Reverse mortgage: pros and cons

When I tell people I do counseling for reverse mortgages, invariably I’m asked, “Are they a good thing?” The initial answer is, “It depends.” The rest of the answer is long, so get comfy, and let’s start at the beginning.

What is a Reverse Mortgage?

The reverse mortgage is designed for older adults who want to get access to the equity in their home to help them stay in their home. For most older adults, income decreases significantly in retirement, making it harder to qualify for or afford other types of loans. A major difference between the types of home loans is that a reverse mortgage does not require payments. (Yes, you read that correctly.)

The first reverse mortgage was reportedly issued in Portland, Maine in 1961, when a banker was looking for a way to help a recent widow stay in her home by letting her draw out home equity in cash to replace her husband’s income. The innovative idea spread and grew. It wasn’t until the 1980s, though, that the product became mainstream with the backing of the federal government. The first reverse mortgage that the Federal Housing Administration insured occurred in 1989.

The federally-insured reverse mortgage is called the Home Equity Conversion Mortgage (HECM). There are other types of reverse mortgages issued by individual financial institutions known as jumbo or proprietary loans. These are not FHA-insured and can have different rules and fees from the federally-insured mortgages, so in this article, we will focus on the HECM.

What Are the Qualifications for a Reverse Mortgage?  What Other Conditions Are There?

An HECM loan, the most common reverse mortgage, is available to borrowers who are at least 62 years old. They must have sufficient equity to qualify, which is determined by the homeowner’s age, their current obligations such as current mortgages and liens on the property, and the value of the property.

Questions I also get about reverse mortgages include, “How can you get a loan and not make payments?”  “How does the interest get paid?”

Because payments are not required, the interest is added to the loan balance, which grows bigger instead of smaller, and thanks to that miracle of compound interest, it grows faster as the balance gets bigger. To accommodate the growing balance, the amount a borrower can get from a reverse mortgage is limited.

Three things determine the total amount someone can get from an HECM loan:

1. Home value. The more the home is worth, the more that can be borrowed.
2. Age. The younger a person is, the less they get because they have that many more years to live and the loan balance to grow.
3. Interest rate. The lower the interest rate is, the more slowly the balance will grow, and the borrower can access a greater percentage of the home value. Conversely, the higher the interest rate, the faster the loan balance grows, and less equity can be borrowed.

The loan must be paid in full when the borrower no longer lives in the home. This can happen through the borrower’s death, sale of the home, or a transition to another permanent living situation like a nursing home. Usually, the loan is paid off through the sale of the home. Any remaining equity goes to the borrower or their heirs. One important feature of the HECM loan is that neither the borrower nor their heirs are on the hook for any “deficiency balance.” A deficiency balance occurs when the loan balance becomes greater than what the home is worth. They only pay what the home is worth at the time of sale or the loan balance, whichever is smaller.

The lender cannot go after the borrower’s other assets or their estate to pay off the loan. That protection is thanks to the mortgage insurance that the borrower must pay for, and it is a significant amount. There is a large upfront premium, along with other fees and costs of the loan that are paid at closing. Usually, these upfront costs are subtracted from the loan amount and are part of the loan balance. HECM loans are expensive — in the many thousands of dollars. The more your home is worth, the more expensive they are.

The loans are federally insured but issued by private lenders. All lenders must be approved by the U.S. Department of Housing and Urban Development (HUD) and complete training and continuing education. Over the years, HUD has made changes to the program to protect borrowers more from questionable practices by lenders or others trying to sell something to the older citizen. One enhancement was to require the borrower to receive counseling from a HUD-certified financial counselor who has completed HUD-approved training, passed an exam, and be recertified every three years.

The counselor issues a certificate stating the borrower completed counseling and demonstrates understanding. HUD has strict protocol on what is covered in the counseling session and what a borrower needs to know, including:

• An assessment of whether or not staying in the home is a reasonable expectation (health wise and financially).
• An estimate of the costs of an HECM loan.
• Alternatives to an HECM loan.
• Tax implications or impact on public benefits.
• Continuing homeowner responsibilities (e.g., property taxes, home insurance and maintenance) and consequences of not taking care of those responsibilities.

Is a Reverse Mortgage Right for You?

Nearly 90 percent of Americans between 50 and 80 want to remain in their current homes as they grow older, according to an AARP-sponsored poll. A reverse mortgage can:

• Pay off a current mortgage that has payments which are no longer affordable.
• Replace the income of a deceased spouse.
• Help pay for in-home care.
• Provide extra income to enjoy retirement.

But the reverse mortgage can also be an unwise choice, depending on the answers to these questions:

• Is the borrower being talked into a reverse mortgage by a lender, family member or salesperson for the latter’s own gain?
• Is it unrealistic that the borrower can remain in the home?
• Does the borrower lack a basic understanding of how HECM loans work?
• Are there plans to move within a few years?
• Does the borrower have a strong desire to leave something to heirs?

For any older homeowner, the answer to the question, “Is a reverse mortgage right for me?" remains, “It depends.”

LSS Financial Counseling is the largest provider of HECM counseling in Minnesota, and we have HUD-certified housing counselors who can explore whether a reverse mortgage is the right choice for you or a loved one. We provide trusted, nonjudgmental advice and support in this area and for those who are pursuing homeownership. Call us at 888.577.2227 to set up a free, confidential appointment.

Mary Ellen Kaluza is a HUD-Certified Reverse Mortgage and Housing Counselor with LSS Financial Counseling.