Pulling equity out of your home through a reverse mortgage seems to go against the American dream of living proudly in a fully paid-for home. This, combined with the bad reputation that reverse mortgages have sometimes had, is why most people are hesitant to pursue these loans.
But over the past decade, the US Department of Housing and Urban Development has tightened regulations to protect consumers. HUD backs and oversees approximately 95% of reverse mortgages, and growing, some pension experts believe these loans can be part of an overall investment strategy that allows people to stay in their homes as they age. “Like any financial product, reverse mortgages can be a great tool,” says Jennifer Fraser, director of stakeholder engagement at GreenPath Financial Wellness, a nonprofit financial advisory service. “They work well for some people and don’t work for others.”
Reverse mortgages have been around for about 60 years, but in 1989 the law was changed to allow the Federal Housing Authority to back reverse mortgages through an FHA-approved lender, and the mortgage of home equity conversion was created. HECMs are the only federally insured reverse mortgages.
The following decades, however, proved a bumpy road for these loans. Stories abounded of people taking out loans without fully understanding – or being told – the details. A minority of borrowers lost their homes because they did not have enough money to cover property taxes, home insurance and home maintenance. Once they defaulted, they faced foreclosure. “A combination of updated regulations and research means that reverse mortgages are now safer for consumers,” says Wade Pfau, professor of retirement income at the American College of Financial Services.
Reforms, pitfalls and misunderstandings
First, the basics. A reverse mortgage is a loan with compound interest, but unlike a traditional mortgage, you or your estate pay back the principal and interest when the loan ends.
Federally insured HECMs have strict requirements. You must be 62 or older, and as of 2022, the loan cannot be based on a home value greater than $970,800, even if the home is worth more. Generally, you must have at least 50% equity in the home, which must be your principal residence. In 2021, the average age of a HECM borrower was 73, with an average home value of $415,000, according to Steve Irwin, president of the National Reverse Mortgage Lenders Association. In addition to HECMs, a small number of private reverse mortgages are available in some states from specific lenders. Typically, private reverse mortgages are best suited for someone under 62 who owns a high-value home or lives in a condominium. Condos are not always eligible for HECMs.
Lender repossesses a home when the borrower dies or moves out for more than a year, but the heirs are entitled to any residual value of the property and can even use it to pay off the reverse mortgage and get the house back. Because a reverse mortgage is considered a non-recourse loan, you or your heirs cannot owe more than the fair market value of the home. Mortgage insurance, which the FHA requires borrowers to have, protects the lender if the home’s value drops.
But other pitfalls exist, some of which have been solved by HUD. The agency now requires borrowers to receive counseling at HUD-approved sites before entering into a HECM and limits the amount a borrower can withdraw at closing or in the first year of the loan. HUD also requires a financial assessment of the borrower’s sources of income, including Social Security, pensions, and investments. The amount you can borrow depends on your age (older homeowners generally receiving more) and the value of your home, the amount of equity in it, and interest rates. Although other debts are taken into account, there is no debt-to-income ratio requirement.
An important provision addressed by HUD concerns spouses who are not named on the reverse mortgage. Prior to 2014, the non-borrowing spouse could be evicted from the home or required to repay the reverse mortgage if the borrowing spouse died or moved into an assisted living facility. HUD made it easier for an eligible non-borrowing spouse to stay in the house, although reverse mortgage payments cease. The reverse mortgage is repaid when the non-borrowing spouse dies or leaves the house.
HUD changes helped. The number of reverse mortgage defaults fell to around 1.5% in 2019 from between 3.6% and 5% before 2014, Irwin says. According to the HUD, 49,207 HECMs were subscribed in 2021. Still, some people still don’t know what a reverse mortgage is, says Cora Hume, an attorney with the Consumer Financial Protection Bureau’s Office for Older Americans. “If people release a product and don’t understand it, that’s a problem.”
Irwin notes that about 40% of potential applicants who go through loan counseling decide not to continue. Expenses are a factor. Reverse mortgage fees, which are usually built into the loan, can be high. For example, the fees and required mortgage insurance are about $25,000 for an $800,000 home, according to Pfau.
Reverse mortgages themselves can be repaid in four different ways: a lump sum when taking out the loan; tenure, which is equal monthly payments as long as at least one borrower lives and continues to use the home as their primary residence; term, which consists of equal monthly payments over a specified period; or a line of credit, also known as a standby mortgage, which can be used until the money runs out. Only the lump sum payment option entitles you to a fixed interest rate. Everything else has a variable rate.
A built-in wallet neutralizer
Although most people think of reverse mortgages as a standalone loan, it’s time to think about them differently, says Jack Guttentag, professor emeritus of finance at the Wharton School at the University of Pennsylvania. “The way their full power can be realized is in the structure of a pension plan.” For example, he says, typically as people age they are told to reduce portfolio risk by holding fewer stocks. If you have a HECM line of credit, he says, it acts “like a built-in neutralizer” for a richer equity portfolioallowing you to stay invested in stocks longer.
That’s why Ken Hillenburg, 72, of Temecula, Calif., decided to take out a reverse mortgage on the home he and his family have lived in for 34 years. A career in medical sales left him with a nice portfolio, but after retirement he began to think about how he could leave the most to his three adult children. Hillenburg had seen the television commercials touting reverse mortgages and had a rudimentary understanding of them. Although her home is currently valued at around $850,000, real estate prices in her area have fluctuated significantly over the years.
After much research, he decided to take out a reverse mortgage, using some of the money to pay the existing mortgage on the house, which was around $1,500 a month, and living off the rest. “We can now spend wallet money by choice, not necessity, and we’ve protected the house,” he says. “There will always be a fair amount of fairness depending on how long we live,” he says. “And if we go in the middle of a serious housing crisis, the children will not be responsible for anything.”
Pfau says that if people plan to stay in their homes for the foreseeable future and want to use a reverse mortgage as part of their retirement strategy, “it makes sense to incorporate it as soon as possible rather than leaving it last. appeal”. A line of credit through a reverse mortgage is like an insurance premium, he says. If you never need the insurance, “that’s fine, and if you do, you have it.”
Hillenburg used government and independent third-party websites to conduct its research, rather than lender sites, to obtain as objective information as possible. The Consumer Financial Protection Bureau, reversemortgage.org, which is operated by the National Reverse Mortgage Lenders Association, and AARP offer a variety of information, including reverse mortgage calculators.
Reverse mortgages are certainly not for all older homeowners, Irwin says, and people should never feel pressured into one, “but for the right person under the right circumstances, this is a safe and good option to consider for effectively aging in place.”