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   ARTICLE   |   From Scotsman Guide Residential Edition   |   February 2015

Do Your Banking at Home

Reverse mortgages can be a powerful retirement solution for your clients

Do Your Banking at Home

The reverse mortgage is still seen by many as an act of desperation for borrowers in need. Television and radio financial planners have generally held a narrow view of reverse mortgages, and consequently dismissed them outright.

With recent regulatory changes and a renewed focus on financial planning advantages, however, the tide seems to be turning. Today’s Home Equity Conversion Mortgage (HECM) is no longer the reverse mortgage you thought you knew. This new reverse even has media figures and financial planners finally recognizing its value as a powerful retirement solution. Now may be the time for brokers and loan officers to take another look at how reverse mortgages can help their retired clients turn unused equity into a steady supply of cash.

Before jumping on the reverse band-wagon, however, loan originators should learn the truth about reverses, starting with how they were — and still are — perceived by many in the mortgage community, as well as by potential clients.

The common perception

In the past several years, retirement portfolios were harmed by the recession, and pension plans in the private sector became scarce. Consequently, many baby boomers had not saved enough for retirement at a time when advances in medicine were increasing longevity. These and other factors have caused legitimate fears about cash flow for many older homeowners.

At the same time, the public came to realize that reverse mortgages could be useful as a way to cash out home equity. Retirees who were “house rich and cash poor” were able to use reverse mortgages as a virtual ATM. Many in the industry had a shortsighted view of reverse mortgages, and loan originators often sold them with a sales pitch along the lines of:

“You need cash. Here is a tool that will pay off your mortgage. It even gives you more cash than you need. You never have to make principal and interest mortgage payments again. Yes, your loan balance will rise, but fortunately, the loan is non-recourse, which means you’ll never owe more than the value of your home. You may not have equity in the end, but if there is no economic benefit for your heirs to sell it, they can simply allow the bank to take the home as payment.”

How perception changed

Interestingly, financial-planning research helped change the perception of reverse mortgages. John Salter, author of “Standby Reverse Mortgage: A Risk Management Tool for Retirement Distributions,” published in the Journal of Financial Planning, demonstrated how effective reverse mortgages can be at hedging against what he describes as “longevity risk.” His research offers an outstanding, if technical, explanation of the prudent use of reverse mortgages in retirement.

As time passes, traditional retirement funds get consumed and there is a greater likelihood that a retiree’s funds will not survive. The untapped line of credit, however, will continue to grow and offer a standby source of retirement funds. A homeowner’s portfolio declines can be offset by the addition of a growing line of credit over the same time period. This is the very definition of a hedge. In this case, it is an insurance against longevity.

Regulatory changes have also played a part in changing perceptions about the program. Fixed-rate reverse mortgages originated prior to 2013 provided large upfront distributions, which didn’t help the perception problem. New U.S. Department of Housing and Urban Development guidelines, however, limited initial disbursements, and shifted the trend back to smaller, periodic draws and/or lines of credit that preserve funds for later.

Even though reverse mortgages do not require monthly principal and interest payments, beginning March 2, 2015, lenders will be required to evaluate every borrower’s “willingness and capacity” to meet their other property-charge requirements, like property taxes and hazard insurance. As a result, a financial assessment that includes credit and income analysis will be required for the first time.

In many ways, however, the perception problem was because of misunderstandings of the program and its varied uses. Reverse mortgages have always been a solid retirement planning tool. The developers of the federally insured HECM program never intended for reverse mortgages to be just loans of last resort for home-owners in crisis. It was their intent that senior homeowners would consider reverse mortgages to supplement their incomes during retirement.

It is important to remember that home equity is a nest egg,
even though it has historically been a hard egg to crack.

Reverse mortgages were intended to be broad enough to benefit the baby boomer generation as a financial planning solution. It was designed to become the fourth pillar of a stable, successful retirement — Social Security, pensions, savings and home equity.

The new perception

The current reality is that reverse mortgages are now being advocated by educated financial planners, advisers and mortgage brokers. They are even recommending home-equity conversion plans for clients who are not cash poor and have no immediate need for them. Why? For one thing, baby boomers have a disproportionate amount of retirement savings held in home equity, and diversifying their sources of income will help their smaller, more traditional retirement funds last longer.

It is important to remember that home equity is a nest egg, even though it has historically been a hard egg to crack. Accessing those funds once meant selling and downsizing. Many boomers, however, want to stay in their homes. So, draws from home equity provided by a reverse mortgage work well because they get the income periodically, just like other forms of retirement — but, in contrast to others, the mortgage draws are tax-free.

Reverse mortgage lines of credit provide another advantage to doing a home-equity conversion early. These lines of credit give homeowners access to funds that grow in their favor at current interest rates. The increased funds can be accessed at a later date, and are easily converted to monthly income whenever needed.

Because of this compounding growth, it makes sense to opt in as early as possible. Then borrowers can make payments to reduce their loan balance if able and draw upon the increased funds at a later date as a form of tax-free retirement income. Consequently, with all the changes made to reverse mortgages in recent years, the following is an example of how brokers should now explain reverse mortgages to their clients:

“You need greater assurance that your funds will last through retirement. Here is a tool that offers a secure line of credit that’s available when you need it. Your available line of credit even grows over time, so it makes sense to obtain one now. As rates go up, your available line of credit grows even faster. You have the option to make payments that reduce your balance and increase your line of credit. Plus, the availability of your funds is not dependent upon your future home value. The longer you live, the more funds you have accessible.”

•  •  •

Many factors led to borrowers using reverse mortgages for immediate cash in the past, but the common view of the product resulted in misuse and misunderstanding of the program’s intent. Although the reverse mortgage is still used by borrowers in need to prevent foreclosure or bankruptcy, the program is now being increasingly touted as something all homeowners age 62 or older should consider to be another element of their retirement portfolios. Brokers with retirement-age clients should take a closer look at this program. It’s likely not the reverse mortgage you thought you knew. 


 


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