Reverse Mortgage 101

_rmRemember the first house in my previous column entitle, “The Price of Shelter—A Tale of Two Houses?” Well, call this article part two—with a wake-up call.

The owner of the first house— the Los Angeles house, that was listed on the online real estate sales website Zillow.com, for around $365,000– passed away last Monday at the age of 78. Her husband died many years ago and they had no children. She has two surviving brothers. Upon her passing the heirs learned that their sister had a reverse mortgage on the house. What will this mean for them and this $365,000 house? Let me start with a little history about what a reverse mortgage is.

A reverse mortgage is a way for people over 62 to access the equity (built up cash value) in their house. The idea of a “reverse mortgage,” originally called an” actuarial mortgage in the form of housing annuity” goes back to 1961 when a first so-called home equity loan was made to the widow of a Maine football coach. In 1969 Congress held hearings on the idea of allowing seniors to access the built up cash value in their homes, called “home equity.” In 1975 a prominent business school wrote a feasibility study on the idea of a reverse mortgage. In 1983 a U. S. Senator suggested further investigation of the “new idea” of home equity conversion, holding the first congressional hearings with the idea of FHA insurance on home equity conversion loans. In 1987 a reverse mortgage pilot program started resulting in some 200-300 letters a day about the program. In 1988 President Reagan signed an act into law authorizing FHA (Federal Housing Administration) to insure reverse mortgages, choosing the first 50 lenders by lottery, and instituting a required counseling program to educate consumers about reverse mortgages. The first FHA insured reverse mortgage was made in Kansas City. The first year 157 reverse mortgages were issued with the average age of the borrower around 76, with access to around 30 percent of their home’s equity and up-front fees of around $4665. Since 1994 the demand for reverse mortgages has increased, so much so that in 2013 new rules were adopted limited how much consumers could borrow to around 60 percent of the home’s value, adding a cap on the value of a home to $625,500, plus more rules to make sure borrowers can pay the taxes and insurance on their homes.

So the owner of the first house from my previous column, at some point, took out a reverse mortgage that now has a payoff of around $165,000. What this means is that the owner decided to take the equity out of her house and probably received a lump sum cash amount—of less than $165,000. When she took out the loan, as with all reverse mortgages, there were “up-front” fees to be paid—the closing costs, the loan origination fees (appraisal fees and such), a loan servicing fee, a premium for the mortgage insurance, plus paying for the required consumer counseling. In addition, when the lump sum is given out, or a line or credit, or any combination, including smaller monthly amounts, the lender charges an annual interest rate on the loan balance which is around 5 percent. The 5 percent interest makes the original amount borrowed increase so that the loan balance actually goes up—not down as with a traditional mortgage.

The person who takes out a reverse mortgage can continue to live in the house but has to pay the property taxes and homeowner’s insurance or risk foreclosure. It the owner vacates the house for 12 straight months this can also trigger a foreclosure. After the last person dies, such as in the case of the owner of the Los Angeles house, the loan becomes due. The amount due can only be determined by getting the actual payoff from the reverse mortgage lender. In the case of the Los Angeles house, the heirs were starting to feel “a little bit” rich until they discovered that there was a reverse mortgage on the house. Their options are to sell the house, pay off the loan, and take whatever is left. Or they can try to finance the reverse mortgage loan so they can keep the house and then probably sell it, or they can add up all the numbers and see what the margins are, and then maybe just walk away from the property and let the reverse mortgage lender have it. The lender will sell it, pay off its loan and any fees to sell it, and then pay any balance to the heirs.

Some critics say that a reverse mortgage is a bad idea period. They say it robs heirs of assets in the form of home equity. In some cases, the owners actually take out a lump sum of cash and spend it then realize they cannot pay the taxes and insurance on the house leaving them worse off and homeless. Some borrowers have taken cash out of their houses and then been hoodwinked into investing the money with shady financial advisors. Critics say that instead of taking out a home equity conversion mortgage that homeowners are better off selling the house and down-sizing. They especially feel that if there is a chance that the homeowners will require some type of nursing home or skill care facility, that a reverse mortgage is a bad idea.

Others say that reverse mortgages can provide a way for cash-strapped home-owners over age 62 to access needed cash. Some homeowners don’t have heirs to worry about leaving assets to so for them they don’t want to leave a large estate in the form of home equity for some probate court and probate lawyers to steal. Some homeowners don’t want to leave their heirs anything anyway. These homeowners know they “can’t take it with them” so they pull their money out and use it. Still, by law, even these homeowners cannot take out 100 percent of their home’s equity from a reverse mortgage. The new law limits the amount of a home equity conversion mortgage to 60 percent of the home’s value—at least in the first year. These borrowers must also prove that they can pay the taxes and insurance on the home. Still for these homeowners, they can still sell their homes, pay off the loan, along with all the fees that may have increased the amount owed.

If you are considering a reverse mortgage, don’t be fooled by slick ads. Consult a trusted financial advisor. Talk with your bank or other lender and explore alternatives. If you are considering a reverse mortgage have the lender provide you with all the numbers—exactly what it will costs in up-front fees, what you will pay in interest each month on the loan balance and how much that comes to each year, and how much over a longer period of time. Take a long look at the cost of a reverse mortgage. Don’t be afraid to ask, what happens to my house after I pass away if the house is worth more than the loan. What if the home is worth less than the reverse loan balance, then what? If you have children discuss your plans with them about taking out a reverse mortgage. Look at all the pros and cons before you sign on the dotted line.

Copyright 2014 – L. Arthalia Cravin. All rights Reserved. No part of this commentary may be reproduced, stored in a retrieval system, or transmitted by any means, electronic, mechanical, photocopying, recording, or otherwise, without written permission from the author.

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