Beyond the Commercials: Understanding Reverse Mortgages
You have likely seen the commercials for reverse mortgages. While the advertisements urge viewers to “call now to secure you reverse mortgage today” and make them seem risk-free, obtaining a mortgage of this type is a serious decision that should not be made without fully understanding its pros and cons.
A reverse mortgage is a loan available to homeowners who are 62 years or older that enables them to convert part of the equity in their home to cash, ideally to cover basic monthly living expenses and pay for health care (though there is no restriction on how proceeds can be used). The amounts that can be borrowed are determined by a formula that takes into account the percentage of the home’s value based on the borrower’s age and current interest rates.
With a traditional mortgage, the borrower makes payments to the lender. The reverse mortgage “reverses” that payback stream so that the lender makes payments to the borrower in the form of a steady stream of income (annuity), a lump sum payment or a line of credit he or she can draw on. The loan is not required to be paid back until the home is sold or vacated. If the homeowner(s) die, the loan must be paid back either through the sale of the home or with other funds from the borrower’s estate. If the loan amount exceeds the value of the home when the loan comes due, the house becomes the property of the lender. Reverse mortgage terms mandate that borrowers continue paying property taxes and homeowner’s insurance, so default on the loan is still possible even though there are no monthly payment obligations.
Home Equity Conversion Mortgages (HECMs) are by far the most popular types of reverse mortgages. HECMs are created and regulated by the U.S. Department of Housing and Urban Development. A HECM is not a government loan, but is issued by a private bank and insured by the Federal Housing Administration. In recent years, the HECM program has experienced increasing defaults and it was discovered that many borrowers are confused about what a reverse mortgage really is (thanks, at least in part, to deceptive advertising common in those TV commercials). Instead of using the loan as a long-term financial tool, borrowers were using it as a last-ditch effort to manage a money crisis.
As a result, in 2013 many reforms were brought to the HECM program. The major changes included:
(1) Limiting the amount of money that can be disbursed at closing or during the initial year after closing;
(2) Requiring a financial assessment before granting loan approval so that borrowers demonstrate their ability to meet all their housing obligations, like taxes, insurance, and maintenance.
(3) Requiring set asides for payment of property taxes and insurance out of line of the credit or tenure/term payments for some borrowers.
Hopefully, the changes will improve the program and help seniors use reverse mortgages in the way that they were intended to be used.