I have to admit I get a little annoyed at some of the articles and advice published in the media about reverse mortgages. Pundits and journalists generally mean well, but the advice they give is often based on the the rampant misinformation circulating about reverse mortgages. Case in point: a “Dear Penny” column that appeared in the Tampa Bay Times a while back. “Penny” is Robin Hartill of The Penny Hoarder. Like many commentators, she means well, but her advice about reverse mortgages is misinformed and misguided and I’d like to set the record straight.
I freely acknowledge that a reverse mortgage is not the perfect solution for every senior. There are some situations where a reverse mortgage doesn’t make sense or is downright inappropriate. However, many seniors who can benefit from a reverse mortgage often don’t get one because of the rumors and misinformation they’ve heard.
Before we dig into my criticisms and corrections, let’s first cover a few basics. If you’re already familiar with reverse mortgages, feel free to skip past the next section.
Reverse Mortgage Basics
The most common reverse mortgage product in the United States today is the FHA-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, it’s a good bet it was a HECM.
The HECM reverse mortgage is designed to give homeowners 62 or older the ability to convert a large portion of their home’s value into tax-free cash without taking on a mortgage payment or giving up ownership of the home. As long as you live in the home and stay current with property taxes and homeowners insurance, no monthly payments are required and the loan balance does not have to be repaid.
You always retain title ownership of your home, which means you’re free to will it to your heirs. If your heirs wish to keep the home, they can pay off or refinance the reverse mortgage balance. If they’d rather not keep the home, they can sell it on their own or let the lender sell it. Any equity left in the home after the reverse mortgage is repaid goes to your heirs.
The HECM reverse mortgage is highly versatile and can be tailored to your financial needs and goals. Proceeds can be received in the form of a lump sum, line of credit, term or tenure payments, or some combination of all of these.
The HECM is a non-recourse loan, which means you’ll never leave a big financial mess to your heirs. If the home isn’t worth enough to settle the entire balance, the shortage is covered by the FHA insurance fund.
Seniors commonly use a reverse mortgage to eliminate existing mortgage payments, pay off other debts, finance home improvements, pay for medical bills, or supplement existing retirement income and assets.
Setting the Record Straight
Now that we’ve covered some basics, let’s get back to Penny. Here’s the reader question that prompted Penny’s response:
I am a 65-year-old, semi-retired single female. Because of my personal and financial situation at the time, I started collecting my Social Security. I needed it to supplement my part-time income in order to just live. It’s not much — under $600.
The problem is, the family-owned business I have worked at for a very long time is in danger of closing. To complicate matters, I live quite a distance from any city large enough to find more part-time work.
I have very little savings but own my home. Would a reverse mortgage work for me? Any other suggestions?
It’s pretty obvious that “N” has a highly uncertain financial future. The family business she works at is failing and the only other income she has is a meager Social Security check. She has very little savings to fall back on, but she owns her home free and clear. It seems like “N” could be a good candidate for a reverse mortgage, right? Here’s how Penny starts off her response to “N”:
Tom Selleck makes it sound so simple in those AAG commercials where he touts reverse mortgages as a way for seniors to have a secure retirement while staying in the homes they love.
Of course, it’s safe to assume that Selleck — whose estimated net worth is $45 million — isn’t in need of the product he’s shilling. But it’s easy to understand the appeal of a reverse mortgage for average senior citizens (emphasis mine).
It’s pretty obvious Penny is not a fan of reverse mortgages. This is sad, because she’s essentially talking “N” out of an option that could provide a tremendous amount of financial security. By accusing Selleck of “shilling” for reverse mortgages, Penny is essentially accusing him of being a huckster or conman. Not exactly a compliment, right? If Selleck has a $45 million net worth, then yes, he probably doesn’t need a reverse mortgage himself. However, he probably also doesn’t need the paycheck he’s earning for doing reverse mortgage commercials. Maybe he’s just pitching reverse mortgages because he likes the product and thinks it can benefit seniors. We don’t always have to be cynics and assume a nefarious agenda, do we? I think it’s safe to say we’re not going to get a balanced opinion about reverse mortgages from Penny.
After explaining some reverse mortgage basics (which, to Hartill’s credit, are reasonably accurate), Penny continues:
You’ll also pay hefty fees to get a reverse mortgage, including closing costs, a 2% mortgage insurance premium up front and a loan origination fee of $2,500 or 2% of the first $200,000 of the home’s appraised value, plus 1% of its additional value.
It is 100% true that the fees for a reverse mortgage can be expensive, but they are not always expensive. There’s a little more nuance to this issue. First of all, all mortgages have closing costs that can add up to thousands or tens of thousands of dollars, depending on the loan. Yes, there are so-called “no cost” mortgages out there, but they’re not really “no cost”. The lender still has to hire title, escrow, appraisal, etc., but they’re charging a slightly higher rate and absorbing the costs for you.
Lenders can usually only afford to absorb closing costs on larger loan balances. For example, a $400,000 loan balance accrues a lot more interest than a $100,000 loan balance. That’s why it’s easier for lenders to offer “no cost” loans on larger loans than it is on smaller loans.
The same is true of reverse mortgages. The problem, however, is that most reverse mortgages start off relatively small. With a traditional mortgage, you borrow a large amount of money at the outset and pay it down in installments over time. A traditional mortgage generates a lot more interest revenue than the typical reverse mortgage.
Reverse mortgages, on the other hand, start off relatively small and more money is borrowed over time. The entire loan balance is paid off in one lump sum after the last borrower (or non borrowing spouse) permanently leaves the home. Because reverse mortgage balances tend to start off relatively small, the lender has less ability to absorb closing costs. Therefore, the closing costs are passed on to the borrower (and usually rolled into the starting loan amount).
Reverse mortgage closing costs are also higher because of IMIP, which is charged by FHA to insure the reverse mortgage. The FHA insurance makes it possible for the HECM reverse mortgage to be non recourse, which means you’re never be responsible to pay back any more than the value of the home. Try finding a forward mortgage that offers that! 🙂
Now, having said that, the reverse mortgage lenders are often willing to give you a lender credit to cover all or part of the closing costs. This is particularly true if you’re starting off with a large balance. For example, if you’re paying off a large existing mortgage, your starting balance may be large enough for the lender to cover all or part of your closing costs.
Now, back to Penny:
You’re still responsible for property taxes, home insurance and any homeowner association fees. Fall behind on these, and your lender could foreclose on you. That’s a real concern I have for you should your income drop significantly.
Sorry Penny, but this one is kind of ridiculous. Seriously? Penny, have you never had a mortgage in your life? Any mortgage lender will require you to pay property taxes and homeowner’s insurance. If you don’t keep your home insured, the lender will buy expensive forced-placed homeowner’s insurance for you.
If you don’t pay your property taxes, the county will eventually foreclose – whether you have a mortgage or not. HOAs often have the power to foreclose or file liens over unpaid dues as well.
Frankly, by freeing up extra cash, the HECM reverse mortgage makes it easier to pay for taxes and insurance – which can be a huge financial burden for many seniors. Many seniors don’t bother insuring their homes because they can’t afford the premiums. This puts them at risk of a huge loss if , God forbid, their home burns down or is damaged by a storm. A reverse mortgage can make it easier for seniors to protect themselves and their home with insurance.
But if you decide to pursue a reverse mortgage, try to wait as long as possible. Generally, the older you are when you take out a reverse mortgage, the higher your payout will be.
With respect to Penny, this is poor advice. Unfortunately, many people (including Penny, apparently) still see a reverse mortgage as a loan of last resort. Here’s the reality: if you’re broke and desperate, there’s a good chance you won’t even qualify for a HECM reverse mortgage. In my opinion, the HECM reverse mortgage is best used as a safety net by seniors who are at least reasonably financially stable.
If you owe little to nothing on your home and don’t need the money from a reverse mortgage right now, you’re a prime candidate. In your case, I recommend getting a reverse mortgage immediately and taking the proceeds as a line of credit. The line of credit is fantastic because it essentially converts a portion of your home’s value into a tax-free retirement account. It comes with a guaranteed growth rate that causes the line of credit to grow and compound larger over time with no limit. This gives you access to more equity automatically over time.
If you want to maximize the size of your line of credit, the best time to get it is as soon as possible. Yes, you tend to qualify for more as you get older, but you’ll get far more by getting the line of credit early and letting it grow and compound over the years.