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   ARTICLE   |   From Scotsman Guide Residential Edition   |   February 2013

Turning Equity Into an Income Stream

Reverse mortgages can help seniors stay in their homes with much-needed funds

Turning Equity Into an Income Stream

As the population ages, reverse mortgages may well be catching on. This is a loan vehicle that every mortgage originator should be educated about as the aging baby boomer generation begins to view it as a way of financing their retirement.

A reverse mortgage is almost like a mirror image of a regular mortgage. It enables homeowners 62 years or older to convert part of the equity in their homes into generally tax-free cash without having to sell the home, give up title or take on a new monthly mortgage payment. Borrowers retain the title to the home, and the reverse mortgage comes due when the borrowers permanently move out, when the house is sold or upon the death of the borrowers.

Here are a few things that mortgage professionals should familiarize themselves with as they consider working in the reverse market.

A growing niche

Until recently, reverse mortgages were not popular, as many older homeowners were afraid of debt. Having grown up in the Great Depression, this last generation of seniors did everything in its power to avoid borrowing money. It was common throughout the 1950s, the ’60s and into the ’70s for families to pay off their mortgages in 20 years and then live debt free into retirement. This is certainly not the norm for baby boomers in today’s market.

For some perspective on recent changes in the reverse market, in fiscal year 2003, only about 18,000 reverse mortgages were guaranteed by the Federal Housing Administration (FHA), but more than 54,000 were originated in fiscal year 2012. These mortgages can help cash-strapped seniors or those looking for new ways to plan for retirement.

The reality for many seniors is that the home they are living in currently may be the cheapest housing option available — certainly cheaper than assisted living or a condo that they would have to purchase at today’s prices and rates. This is a particularly cruel reality if you have been living mortgage free for a number of years. Even for seniors with a well-funded retirement, reverse mortgages can help with unexpected expenses and other cash-flow issues, while letting borrowers stay in their homes.

Requirements

The requirements for reverse mortgages are relatively simple. The borrower must be at least 62 years of age, and the home must be mortgage free (or with enough equity to be refinanced under the constraints of the reverse mortgage). There are some fees involved, which generally can be rolled into the mortgage. There is no income requirement, and credit isn’t typically taken into consideration, although FHA is currently in the process of establishing guidelines for financial assessments of borrowers. In addition to other credit issues, an unresolved bankruptcy, for example, may cause a borrower to be declined.

Interestingly, the older the borrower is, the more that is available to borrow, but there is a cap on the amount borrowed based on the appraised value of the home.

One of the beauties of a reverse mortgage is the freedom it allows the borrower. Depending on the product involved, the money can be taken as a lump sum, fixed to a line of credit to be drawn out as needed, or paid out in monthly installments, like an annuity. Regardless of which type of pay-out chosen, interest accrues only on the amount collected by the borrower.

Although there are some private lenders that offer reverse products, the majority of reverse mortgages are guaranteed by the FHA and come in several forms: the Home Equity Conversion Mortgage (HECM) Standard, the HECM Saver and the HECM for Purchase. FHA recently suspended the fixed-rate standard HECM and is encouraging borrowers to consider the Saver option.

FHA charges two mortgage-insurance premiums on HECM loans. The upfront premium is based on the lesser of the home’s appraised value, the HECM mortgage limit of $625,500, or the sales price; this premium is charged at closing. The second premium is assessed annually and is 1.25 percent of the mortgage balance. The HECM Saver reduces the upfront mortgage insurance premium from 2 percent down to .01 percent, but it also lowers the amount of money available to the borrower.

Pros and cons

Many seniors may question why a home- equity loan or a second mortgage wouldn’t be a better option than a reverse mortgage. For some, these may, in fact, be better options; mortgage professionals must consider each case carefully.

For seniors who are no longer actively in the workforce, it may be difficult to qualify for a standard loan. The reasons for this are simple: Banks want to be assured that they will get their money back, and many seniors don’t have the income necessary to qualify for the loan. Reverse mortgages may be ideal in this situation because they require no payment until the house is actually sold. In addition, if the borrower’s home value declines to the point that they owe more than the house is worth, FHA will reimburse the lender for the difference when the property is sold. This is covered by the mortgage-insurance premiums paid by the borrower to FHA over the life of the loan. If the home sells for more than was borrowed, the homeowners or their heirs retain the difference.

Some of the built-in advantages of a reverse mortgage include:

  • Nothing is due on the reverse mortgage in the course of the loan.
  • Borrowers can live outside of their home for as long as 12 months before the mortgage comes due.
  • Borrowers will never owe more than their home is worth.

An additional advantage of a reverse mortgage is that it generally does not affect Social Security or Medicare. The reverse-mortgage proceeds are not considered additional income. It can, however, impact eligibility for Medicaid and Supplemental Security Income (SSI). If a borrower receives a lump-sum payment from a reverse mortgage, any amount retained the month after it’s received would count as a resource and could affect SSI or Medicaid coverage. To be safe, borrowers should consult a tax adviser or benefits expert before going too far into the process.

There are some disadvantages to reverse mortgages, so be sure your borrowers know all their options. Like any other loan product, a reverse mortgage is not for everyone. If you are working with a senior who still is making an income and who is in fairly good financial shape, a home equity or a second mortgage may be the better option. Depending on what they plan to do with the money, you also may be able to offer the borrower other avenues to pursue.

For example, if the borrower is looking to replace an old furnace or do other energy-based home improvements, there are many state-run programs that would allow them to borrow money with little or no interest payments. There also is the opportunity for an energy rebate if the improvements fall under Energy Star ratings. Do some research in your area to see what else you can offer.

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Senior borrowers still may be wary of the reverse mortgage, so knowledgeable mortgage professionals should be prepared to answer their questions thoroughly. There are many important safeguards put in place to protect consumers with reverse mortgages: Borrowers are required to be counseled by a third party; there are limits on the interest rate and origination fees; and there is a ceiling placed on what the borrower will owe. These safeguards help to ensure that seniors looking to plan for a secure retirement will not lose their home to the bank, and they will have spare cash to spend as they wish in their golden years.


 


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