Reverse mortgages have a bad reputation. News stories have long detailed how unscrupulous lenders have used these mortgages to scam seniors out of their homes by pressuring them into borrowing against the home’s equity without understanding the risks.
“It’s the elephant in the room.…It was a bad loan for a long time,” says Kevin Walton, a reverse mortgage loan originator and Registered Social Security Analyst with C2 Reverse Mortgage. Prior to legislative changes that began under the Reagan administration, banks had many avenues to take the equity in a home, Walton says. “They took everything. And so, people getting reverse mortgages today, remember that.… Once that taste is in your mouth, it’s like a lemon. You can’t take it out.”
However, Home Equity Conversion Mortgages (HECM), a form of reverse mortgages insured by the U.S. government, are available through Federal Housing Administration-approved lenders, which provides both legitimacy and security for these mortgages. These types of loans allow homeowners to draw upon home equity for repairs and maintenance and/or to cover or lower living expenses.
Differences from traditional mortgages
Unlike traditional mortgages, with a reverse mortgage, borrowers don’t have to make monthly payments. For many, that’s the greatest appeal. Instead, the loan, along with interest and fees that accrue monthly, is repaid when the borrower no longer lives in the home. So the longer you have a reverse mortgage, the more you pay at the end (as opposed to a traditional mortgage where you gain equity as you make monthly payments to the lender or bank).
For many, reverse mortgages allow them to remain in their homes as they age and/or to supplement their incomes. Federal HECMs are available to those 62 and older; however, private reverse mortgages are also available to those aged 55 and older.
Are they right for you as part of your retirement strategy? Here’s what to know about today’s reverse mortgages, according to the experts.
Who’s right for a reverse mortgage?
There are several reasons people consider a reverse mortgage. Many who seek out a HECM are on fixed incomes and use it to fill retirement funding gaps. “[They] are part of a generation that didn’t prepare for retirement the way we are preparing today. They thought they could rely on Social Security or their companies didn’t offer 401(k)s or IRAs,” says Michelle White, a national mortgage expert with The CE Shop. “When they purchased a home, that was their investment. And so, a reverse mortgage is, for some, a way of taking that money out as if it was their retirement investment.”
Walton says even clients with plenty of retirement savings use reverse mortgages strategically. “[They] just want to have funds as a buffer…They’ve been coached properly that you don’t want to take funds out in a down market, because you’re really cutting the legs off of your investment when you do that. So, you have a buffer in the form of the reverse [mortgage] you could draw from until the market returns,” he observes.
Some borrowers also use the funds to restructure debt, finance large purchases (such as bucket-list trips), or to make home repairs.
However, Walton says the majority of his clients opt for reverse mortgages to pay for home health care so they can afford to stay in their homes instead of moving into retirement communities.
Updates to reverse mortgages
In the past, spouses who were not part of the reverse mortgage loan were in a predicament if the borrowing spouse died. (A spouse might not be part of the agreement for a variety of reasons, including that they don’t meet the age requirement or aren’t on the property title.) Because they were not on the loan, they had to immediately refinance, pay off the mortgage, or lose the home.
However, thanks to a 2014 change to the Reverse Mortgage Stabilization Act, surviving, non-borrowing spouses may continue to live on the property after a spouse’s death, or after the spouse has to move into a long-term health care facility as long as a few conditions are met. For example, the non-borrowing spouse must be named on the lending paperwork up front and must have lived in the home when the mortgage was taken out, as well as after their spouse’s death.
Under the current lending program, HECM borrowers must also now participate in counseling sessions to discuss their eligibility, payouts, and what will happen when the mortgage becomes due. White says this education has created big shifts for homeowners and their heirs. “Family members are also being encouraged to take the class with the family member that is getting the reverse mortgage, so that the heirs of the estate will know exactly what’s going on and they’re not getting blindsided,” she says.
Pitfalls of reverse mortgages
Reverse mortgages have several legal requirements that are important to consider upfront. First, heirs can’t take over the mortgages. This is a big turn off for many borrowers who want to leave inheritances through home equity. “[Heirs] typically have six months or less to refinance or pay off the debt,” says Ryan Dossey, co-founder of SoldFast home buying service.
That can be challenging for heirs, particularly if they don’t have good credit. “Overextending beyond what you can do or what your heirs can do is a risk. That’s important [for reverse mortgage holders] to think about, because they might not consider their heirs’ financial picture,” Walton says.
Dossey also warns against the pitfalls of a home being “underwater” — in other words, borrowing more equity in the reverse mortgage than the home is ultimately worth when the mortgage becomes due.
Another potential drawback is that homeowners must keep on top of home repairs and they aren’t always able to do so. “If you fail to maintain the home (which seniors may lose the ability to do physically), it can trigger a foreclosure,” Dossey says. The homeowner must also keep their homeowner’s insurance and property taxes current.
Reverse mortgage interest rates are typically higher than traditional first mortgages, which may also make potential borrowers hesitate. However, this gap has decreased, according to Walton. “About 10 years ago, the rate differential was about 4%. Now… depending if the loan is structured, [it’s] maybe 1¼ to 1¾ [percent] difference,” he says.
Finally, the dwelling must also be the homeowner’s primary residence. While second homeowners and “snowbirds” (people who spend several months out of the year in warmer climates) may want to think twice about reverse mortgages, Walton says the bank only looks closely if the homeowner has been out of the property for 12 consecutive months. “Six months and one day per calendar year is classified as owner occupied,” he says.
Options beside reverse mortgages
If a homeowner’s financial picture has them considering a reverse mortgage, there may be other viable solutions that better suit their needs. For example, the potential borrower could move in with a relative, ask for financial assistance from family, apply for programs that assist low- or fixed-income individuals with utility bills, sublet rooms in their home or use “house hacking.” “House hacking is when you buy a duplex (or similar property) and live in one unit while leasing the rest. Becoming a landlord is not for the faint of heart, but it’s an option worth exploring,” Dossey says.
Overall, Walton hopes people no longer consider reverse mortgages as a loan of last resort. “It’s not just for people in dire straits anymore…Give it a second look. It’s had some major improvements to make it a safer, more viable, user-friendly product,” he says.
Photo by Natee Meepian/shutterstock.com
