On occasion I change my mind on a topic when the facts have changed. Reverse Mortgages are in that category. The program has undergone many improvements as a result of the Reverse Mortgage Stabilization Act of 2013.
Home Equity Conversion Mortgages (HECM) are called Reverse Mortgages for short. “HECMs help seniors remain financially secure by giving them access to the equity that has accrued in their homes at a time when their income is likely to be reduced—by retirement or limited hours—or strained—by higher medical expenses and the increased cost of living. When used responsibly, HECMs help seniors maintain their quality of life and independence.” (Quote from linked HUD article above).
Recently I read a book, “What’s the Deal with Reverse Mortgages?” by Shelley Giordano. She discusses the “HECM 4 Nevers:
- The homeowner and his estate never give up the title to the home.
- The homeowner, when leaving the house, or his estate, can never own more than the home’s value; conversely, when the home is sold, sale proceeds in excess of the debt amount belong to the borrower/estate.
- Even if all the money that can be borrowed through the reverse mortgage has reached its limit, the borrower never has to move, provided taxes, insurance, and home maintenance are continued. (My emphasis – that the provisions are the same as normal home ownership as well).
- Monthly repayments are never required or expected, although voluntary payments are accepted.”
Shelley discusses the differences between traditional and HECMs. She answers many questions one may have about how HECMs work, how money may be drawn, and how costs are paid. She discusses differences between a Reverse Mortgage and a Reverse Mortgage Line of Credit (LOC) where the HECM LOC can serve as a standby emergency fund.
HECMs are eventually repaid and there are flexible options. Homeowners may decide to repay loan balances in full or partially at any time, even though this is not a requirement. Repayment by the borrower, or heir, is made when the last one dies, moves, or sells the home, using the home itself to pay back the loan with no responsibility for any sums underwater (loan with a higher balance than the free-market value of the home).
Heirs can decide to keep the home, in which case they repay the HECM loan through cash, other inherited assets (see my comment on deduction strategy below), or obtaining their own loan to do so. Heirs pay either the current HECM balance or 95% of the appraised home value, whichever is less. If heirs want to sell the home, they have up to a year. There are provisions for heirs if the home is underwater as well with protections for the heirs who cannot be held responsible for any shortfall (HECMs are a non-recourse loan).
HECMs may also be used to finance purchasing of a new home. The old home is sold and the new home is purchased via a HECM with no mortgage payment required (still required are normal home ownership responsibilities I emphasized above). This may be a downsizing strategy. Or alternatively, since HECMs are always tied to the principal residence: “Since there are no limitations on how reverse mortgage funds may be used, it always has been permissible to extract money from the permanent residence to buy a second home.”
Shelley then discusses how recent retirement income research has shown more income or wealth preservation from non-real estate assets. Basically, being able to fund living expenses via what is normally an illiquid assets (the home), allows less need for this income to come from invested assets and thus, those assets last longer than they would having to pay all living expenses on their own. Home equity essentially is an ever growing, idle asset, which may be under, or not at all, utilized asset that HECMs can resolve.
Of particular value, is Chapter 14, “How Do I Choose an Ethical Lender and Get the Best Price?” What kind of lender and costs (you can buy down closing costs with HECMs too) depend on what kind of HECM and how long it might be used. Counter-intuitively, shorter periods may benefit with higher interest rate HECMs (lower closing costs). Line of Credit HECMs with higher interest rates also generate faster growth of the loan proceeds. Work with two or three lenders and ask for loan summaries and amortization schedules “that demonstrate the interplay between upfront costs and home equity retention based on various interest rates.”
This summary doesn’t go into all the details Shelley covers; that’s what the book is for. I review it so you have deeper insight into how the program has changed and improved over the recent years.
You may also learn more at Mortgage Professor.
Book cons: the charts are too small to read and the often referenced website in her book for those charts is not fully functional at the time I’m writing this review (Dec 2015). This said, the book provides valuable insights condensed in one place to make it easier to put all the pieces relevant to you together and on how to approach Reverse Mortgages correctly and more informed.
PS. “Robert Merton on the Promise of Reverse Mortgages … ” Various quotes from the article:
- The house should be viewed as an annuity while you live in it and a financial asset that ultimately gets sold. A reverse mortgage gives up the financial asset when one doesn’t need it, in order to pay for other expenses during retirement that you do need.
- Also, Merton said a challenge remains in what one does when they get the principal (assuming one takes a lump sum). “If you spend it,” he said, “it defeats the purpose.”
- One criticism of reverse mortgages is that it deprives one’s children of a bequest of the remaining value of the house. Merton’s response was that the potential for a bequest still exists with a reverse mortgage. It becomes more like a “lottery ticket” that is won under the most adverse circumstances (when one’s parents die). The children or heirs get an option (a call option) on the value of the house at the time of sale, to the extent that value exceeds the amount due on the reverse mortgage.
- More broadly, though, Merton said retirees should place maintaining their own standard of living ahead of leaving a bequest. He said it is similar to the warning that airline attendants give with regard to the use of oxygen masks. They say to place the mask over your own mouth before that of your children.
PPS. “New Research: Reverse Mortgages, Annuities, and Investments: Sorting Out the Options to Generate Sustainable Retirement Income” suggest “Get it Early, Use it Late” due to low interest rates today.
Because Reverse Mortgages build up interest, there is a potential for heirs to recover a potential lost deduction if they plan properly.
“Recovering a Lost (Large!) Income Tax Deduction: update January 2016”
Dirk Cotton, who is an acquaintance has a couple of great posts on Reverse Mortgages:
“Ten Strategies for Using a Reverse Mortgage to Help Fund Retirement”
“The HECM for Purchase Program Simplifies Home Buying for Retirees”
Dirk again has done a good job summarizing “The Risks of Reverse Mortgages.”
And once again, Dirk brings up some really good points about carefully weighing the use of a reverse mortgage early in retirement
This article by Kitces is a good walk through of how reverse mortgages may be tax deductible
Things to consider before getting a reverse mortgage
Here’s a side by side comparison between reverse mortgages and traditional mortgages
Reverse mortgage info from the horse’s mouth … HUD’s site
“Common Causes For Default Of Reverse Mortgages (HECM Loans)”
A great summary of reverse mortgages up front, and then the meat of the article in the section “Common Causes For Default Of Reverse Mortgages (HECM Loans)” further down the page.
Very good information!