Independent Information on Reverse Mortgages

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"Reverse Mortgages" (excerpted from Long-Term Care: Your Financial Planning Guide, Kensington Books, April 2003, by Phyllis Shelton)

Since the majority of older Americans own their homes and have paid off their mortgages, many people find themselves “cash poor” and “house rich.” Because of these characteristics, a certain amount of activity is occurring in the marketplace to help people tap the value of the home without giving it up as long as they live in it. Converting the equity of the home into cash can be accomplished either through sale plans or loan plans. The sale plans, which involve selling the home then leasing it back as long as the seller is able to live in it, are not popular for tax reasons. It’s possible that the IRS will not view the plan as a bona fide sale if the house is not sold at fair market price, or if the buyer is receiving favorable treatment, or if the buyer does not assume full ownership until the death of the seller. If the IRS does not view the plan as a bona fide sale, the one-time capital gains exclusion is not available to the seller. In other words, people sometimes try to give their kids a bargain, and the IRS doesn’t look favorably at special deals for children or any other buyers.

Home equity conversion loans in the form of reverse mortgages are available, in which no repayment of the loan is generally required until the borrower dies, sells the home, or permanently moves. Started by the federal government in 1988 to help older Americans on fixed incomes, the program allows homeowners over 62 to convert part of the equity in their homes into tax-free income without having to sell the home, give up the title, or take on a new monthly mortgage payment. You must be a single-family homeowner, which can include a condominium or townhouse as long as the development meets FHA guidelines. Other eligible residences are manufactured homes and 1- to 4-family owner-occupied dwellings. Others who are not on a fixed income also see the benefits of “cashing in” on the equity in their home for additional investments. There are no income qualifications and limited credit qualifications, because unlike an equity loan from a bank, a reverse mortgage requires no monthly payments.

The monies available to the homeowner are tax free and don’t count as income for Social Security eligibility purposes. The balance due grows as monies are disbursed to the homeowner. The funds can be disbursed in several ways. Cash available can be taken in monthly payments over a period of years, a lifetime, or as a line of credit you can draw down as needed over a number of years. You can even receive a combination of regular monthly payments and a line of credit. You still own the home. It can be sold at any time (for example, if you decide to move) and when sold, any balance due on the reverse mortgage is paid and the remaining equity goes to you or in the case of your death, to your estate. Equity remaining depends on how long you remain in the home and the value of the home at the time of sale.

The reverse mortgage market is poised to grow substantially as the baby boomers move into their retirement years. As of this writing, there are three products available but that will increase to meet various demands of clients. Presently the most widely used product is FHA’s Home Equity Conversion Mortgage (HECM). The Federal National Mortgage Association, known as “Fannie Mae,” offers a product called the Home Keeper. Fannie Mae doesn’t make direct loans. It buys loans from lenders, packages them and resells them to investors. Financial Freedom, headquartered in Irvine, California, offers the Financial Freedom Cash Account loan, a private reverse mortgage product.

The older you are and the more valuable your home, the more you can borrow. Each program has a “lending limit” and the amount available to the client depends on age, and in some programs, on the number of borrowers (but all have to be over 62). It also depends on the value of the home, the amount of built-up home equity, and the interest rates at the time. Generally, a borrower in his or her early 60’s could get about 38% of the home’s equity, a 75-year-old could get about 58%, and someone in his or her 80’s could get about 60% of the home’s value.

There are also equity share reverse mortgages that allow you to receive a greater cash benefit in exchange for a portion of your home’s future value. The potential amount shared is limited by an overall interest rate cap.

Generally there is no cash out-of-pocket when you get a reverse mortgage. The proceeds of the reverse mortgage will be used to pay off an outstanding first mortgage or any other debt on the home. The associated fees such as the origination fee, the mortgage insurance fee, an appraisal fee and other standard closing costs may be financed as part of the reverse mortgage. You are just responsible for keeping up payments for your homeowner’s insurance and property taxes, and to maintain the condition of your home.

Fannie Mae is utilized more frequently by older, single people than by married people, and the Financial Freedom product is geared to higher valued homes.

If you take the money in monthly payments but live so long that the payments exceed the home’s value, you or your heirs do not have to pay back any amount larger than the worth of your home. All reverse mortgages offered today have built-in consumer protection features that prevent you or your heirs from owing more than the value of your home at the time the loan comes due -- even if your home declines in value. This risk is assumed by the lender. After you die, your children (or other heirs) can keep the home if they like—they just have to pay the balance in full. They can pay off the reverse mortgage using their own money or they can sell your house. If they sell your house for more than is owed, they can keep the difference. Some people (or their children) purchase a life insurance policy on the homeowner when they get the reverse mortgage so the children can use the death benefit to pay off the mortgage and keep the house.

The interest rates on reverse mortgages are adjustable. Interest adds to the balance that will be owed when the property is sold. FHA offers either an annual or monthly adjustable interest rate and Fannie Mae has only a monthly adjustable. FHA’s rate is the weekly average of the one-year Treasury Bill plus a margin of 1.5% for the monthly adjustable or 2.1% for the annual. For example, on December 31, 2002 the one-year T-Bill was 1.36%, so the annual rate was 3.46% and the monthly rate was 2.86%. Fannie Mae’s rate is the weekly average of the one-month CD rate plus a margin of 3.4%. The one-month CD rate on January 31, 2003 was 1.09%, so the rate for a Fannie Mae reverse mortgage was 4.49%. Monthly adjustments to this interest rate will not affect monthly payments, unless you have chosen to take your money as a line of credit. Otherwise, fluctuating interest rates will only affect how much money is owed when you die, move out of your home, or sell your home.

Most of the cash from the various plans has been used for home modifications, home repairs, to weatherize homes, to make homes accessible for the handicapped, for supplemental retirement income, and some of the money is being used to fund long-term care services.

Rather than pay for long-term care services directly, much more “mileage” can be obtained from the money by purchasing long-term care insurance if you are insurable. You can purchase a long-term care insurance policy outright by paying a monthly, semi-annual or annual premium. Some borrowers take the reverse mortgage as a line of credit, then use the interest growth each year to pay their long-term care insurance premiums. Or, a lump-sum obtained from a reverse mortgage can be used to purchase a single-pay long-term care insurance plan that is available in some states or an annuity, which can then be set up to pay the LTC insurance premiums for the rest of the insured’s life. Or, the lump sum can be used to purchase a life insurance or annuity long-term care policy as described on pp. 162-174 that pays LTC expenses with a guaranteed premium.

When implemented by HUD, The American Homeownership and Economic Opportunity Act of 2000 will waive the upfront fee for the mortgage insurance premium for older Americans who use the money from a reverse mortgage for long-term care insurance premium. The value of the waiver is 2% of the lending limit, which varies by state. (For example, a lending limit of $132,000 in Colorado on a $200,000 residence results in a waiver of $2,640.)

For a list of lenders who offer reverse mortgages in your state, call the National Reverse Mortgage Lenders Association at 866-264-4466 or visit the website at www.reversemortgage.org and click on “Find a Lender”.

To make sure families understand the program, FHA requires a free individual information meeting with a HUD-approved housing agency separate from the lender so you can learn about the program objectively and decide if it’s right for you. You can get the name of a local counseling agency or qualified telephone counselor from a reverse mortgage lender or by calling AARP (800-424-3410), Fannie Mae’s Homepath service (800-732-6643) or HUD’s Housing Counseling Clearinghouse (888-466-3487).

Your State Agency on Aging also has information on organizations to contact if you are interested in obtaining a reverse mortgage. An AARP bulletin contained a warning from Andrew Cuomo, the Department of Housing and Urban Development (HUD) secretary. Mr. Cuomo cautioned against salespeople contacting you to do a reverse mortgage and charging hefty fees for information and forms that HUD offers free. He said the legal limit for counseling and referral services is $50, and you should not be charged more than that. If you suspect a scam, you can check out the organization that contacted you by calling HUD directly toll-free at 1-888-466-3487, and HUD will investigate at no charge to you.

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