REAL ESTATE TOPICS:  REVERSE MORTGAGES

By:  John P. Hale, ABR, ASR, CRS, e-PRO, GRI, MRE

February 2008

Let’s clarify something right off the bat.  We’re really talking about a Reverse Loan – not a Reverse Mortgage – even though that’s what everybody calls it.  We typically don’t have “mortgages” in Arizona.  Ownership interest in real estate is normally secured by a Deed of Trust – not a Mortgage.  Perhaps just a technicality to most, but it is an important legal distinction, and for some people, perhaps a significant mental factor as well.  Having said all of that, this writing will continue to use the common terminology: Reverse Mortgage.

So, what is a reverse mortgage?  Simply stated, the most popular product is the Home Equity Conversion Mortgage (HECM) which is a special home loan program established and controlled by the Department of Housing and Urban Development (HUD) and the Federal Housing Authority (FHA) that is only available to senior citizens, 62 years old and older, to be able to benefit from some of the equity in their primary residence in a number of very useful ways that are not otherwise available to them. This is really just another type of loan with many of the same provisions as a regular home loan, a second loan, a refinance, or a home equity line of credit (HELOC).  However, unlike traditional equity loans, no repayment of either principal or interest is required until the home is no longer the principal residence.

Eligible properties include most types of residential properties: condominiums, townhouses, single family (including manufactured homes), and multi family properties up to 4 units.

The home may be owned free and clear or have an existing loan or loans that can be paid off at the time of closing of the new reverse mortgage.

There does have to be some significant equity in the home for a reverse mortgage to work.  There is no 100% Reverse Mortgage or, no 80/20 Reverse Mortgage.  The whole point of a reverse mortgage is to be able to pull equity (money) out of the home you are living in without having to give up the home and without having to make any payments to pay back the loan.  Alternatively, the loan amount or principal, along with the application, appraisal, underwriting, and processing fees and costs, and the accumulated interest charges are eventually paid by deducting those amounts from the final net equity left in the property at the time of its’ sale by the owner(s) or their estate.

Perhaps one of the most amazing things about a reverse mortgage is that there is very little qualification necessary.  It does not matter what the borrowers’ credit score is, what their income is, or even if they are in bankruptcy.  It may even be possible to salvage a tax sale or foreclosure on a home with a reverse mortgage.

Another very important fact is that the customer absolutely retains ownership of the home – just like with any other loan.  There is a Deed of Trust and a Promissory Note held by the lender – just like with any other loan.  And – unlike with other loans – there is a second Deed of Trust and Promissory Note held by the FHA for the protection of the consumer.

Sadly, a very large percentage of our senior citizens are not in especially good financial shape.  Many are struggling to manage on smaller than expected retirement incomes, have larger than expected living expenses, and have ever increasing property tax bills.  Others are in poor health and have huge medical expenses.  Some are very vulnerable – perhaps even desperate.  They may be easily taken advantage of by the types of predators we all hate.  And, prior to 1989 there were many cases of abuse by unscrupulous people that took advantage of many elderly victims.

Consider the stress and confusion experienced by a normal, educated 35 year old couple applying for a home loan – maybe even on their second or third home purchase.  How capable are they at shopping, comparing, and sorting through the maze of loan requirements, options, benefits, and costs?  Typically?  Not so good. So, imagine the anguish and fear of the elderly people described above in trying to make a decision about obtaining a reverse mortgage.

Fortunately, one of the things that is required by the new laws passed in 1989 to help provide protection for seniors (regardless of their circumstances or acumen), before moving forward with the loan processing, is that HUD requires the borrower(s) to attend a training/counseling session conducted by an independent, FHA certified counselor (not connected with the lenders).  This typically takes about one hour and should answer any and all questions and concerns there may be.  Family members, friends, and legal and financial advisors are encouraged to attend this session.

In Tucson, the following organizations can provide that counseling:

Administration of Resources and Choices

P.O. Box 86802

Tucson, AZ 85754

520/882-9135

Catholic Community Services of Southern Arizona, Inc.

848 South Seventh Avenue

Tucson, AZ 85701

520/624-0551

Catholic Community Services of Southern Arizona, Inc.

4732 North Oracle Road, Suite 217

Tucson, AZ 85705

800/308-2227

Catholic Community Services of Southern Arizona, Inc.

55115 East Grant Road, Suite 211

Tucson, AZ 85712

800/308-2227

Chica Nos Por La Causa

200 North Stone Avenue

Tucson, AZ 85701

520/882-0018

The amount of money that may be borrowed will depend on the borrower’s age, the current interest rate, the appraised value (by an FHA certified appraiser) of the home or FHA’s mortgage limits ($271,050 at the time of this writing in February 2008) – whichever is less.  Generally speaking, the older you are (above age 62) the more you will be able to borrow.  The calculation is something akin to the actuarial calculations that life insurance companies use in calculating insurance rates.  The longer the life expectancy, the lower the monthly distribution will be.

Let’s consider an example of how this program can help an elderly couple.  The husband is 92; the wife is 84 and is bedridden.  They have depleted their savings and only have social security income of $1,000 per month.  They have been accumulating unpaid medical bills, have high credit card balances and as a result have eroded their credit rating.  They do own the home they are living in and it has been appraised at $160,000 but their mortgage payoff is $26,000 (monthly payment is $500 per month).  Needless to say, this is not a good situation and can only get worse without some help.

One option for them to consider would be to sell the home and payoff all of their debt.  But, then what would they do?  Their credit scores are going to remain low for some time and as a result they probably won’t be able to purchase another home.  Renting will be more expensive than their mortgage payment was.  They would have to move (another big expense – not to mention the physical and emotional burden).  And, they would be giving up their lifelong home.

Under better circumstances, a refinance of their debt might be an option – but not for them because of their poor credit rating and lack of sufficient income to qualify for a new conventional loan - which, by the way, they would have to pay back with higher monthly payments every month.

Well, the reverse mortgage is definitely something worth learning about and considering.  Based on the HUD formula, this couple could have access to an estimated $82,000 of the equity in their home.  Their debt and credit issues are not factors that come into consideration.  They can choose to receive the money in a number of different forms or combinations of forms.  By the way, their first mortgage would be paid off at closing (not an optional choice) and they would then not have a monthly payment of $500.

They could choose to take all of the $82,000 in cash (maybe not the best choice for this couple).

They could elect to have the $82,000 available as a line a credit to be drawn upon as needed (this might be a good choice if they are financially responsible).

Or, perhaps the best option in this example:  they could choose to receive “tenure” payments for the balance of their life.  In this example, that would mean monthly payments to them of approximately $677 per month for as long as either of them is alive.  If either passes away, the surviving spouse would continue to receive $677 per month.

They might choose to use some combination of the above options.  Just as an arbitrary example, maybe $10,000 in cash up front, maybe set up a line of credit for another $20,000 and then still receive permanent monthly payments of some lesser sum of money each month.

Remember, they do not have to pay any of this money back – as long as at least one of them lives in this home as their primary residence.  And there are no income tax consequences – none.  And, also remember that these folks retain title to their home – just as with any other type of home loan.

They will need to continue to pay their property taxes and maintain adequate homeowners insurance.  Of course this was true before too – but these payments were probably included in their monthly mortgage payment.  But it should be clear that their world is looking a lot brighter because of this program.

What is the cost of this miracle?  It is significant and slightly higher than a traditional home loan.  However, in order to help protect the senior consumer, the government has standardized the costs and fees allowed to be charge for this program to try to minimize abuses by unscrupulous lenders and service providers.  It should not matter which approved lender you use - they should all charge the same amount.  In this example, the total cost would be about $8,500 – which is normally rolled into the loan.  The borrowers do not have to write a check – though they may if they choose to.  About 40% of that amount or $3,400 goes to pay for the FHA required mortgage insurance.  This is a one time charge that covers the life of the loan.  And, unlike the expensive conventional private mortgage insurance that is required to be paid for by conventional borrowers that have less than a 20% down payment, this time the mortgage insurance protects the borrower – not the lender.

The balance of the loan cost, about $5,100, goes to cover the lender’s fee (set at 2% of the loan amount by HUD) and other loan costs.  In this example, the lender’s fee would be $3,640 – which is a little higher than lenders often receive for conventional loans of this amount.  However, their time and effort on a reverse mortgage is usually much more than on a conventional mortgage.  And, they are strictly prohibiting from tacking on any other charges or fees.  The remaining balance of $1,460 goes toward paying the other closing costs such as title insurance, appraisal, escrow and recording fees, etc., etc.  But, that’s what it takes to make this happen.  Is it worth it?  For this couple there can hardly be any argument.

By the way, just like with conventional refinance loans, there is a required three day right of rescission on reverse mortgages.  Should the borrower(s) want to change their minds for any reason within three days of signing, they can – simply by giving written notice of cancellation (for any reason whatsoever).

Alternatively, for those seniors who are lucky enough to be in good health and have adequate financial resources to live “the good life”, this program may also be of interest.  Remember there aren’t any financial qualifiers necessary to take advantage of this program – except having equity in your home.

Let’s consider another example in which the senior couple has plenty of income to pay all of their bills and then some.  They own their home free and clear and it is worth $750,000.  Their ages qualify them for a Reverse Mortgage of $250,000.  By the way, it is always the younger spouse’s age that controls the calculation of the amount available.

They could choose to take that money and go buy a second home.  There are no restrictions on what you do with the money.  They could go to Vegas and put $250,000 on RED and spin the wheel.  It is their money to do with as they wish.

The only consequence (beyond the initial cost of the loan and the continuing interest cost) would be that the equity in their current home would be reduced accordingly.  And, upon the sale of that home, their net equity would be that much less.  Keep in mind though that this is likely going to be offset to some degree by the normal appreciation in value of the home over the same period of time.

It is important to understand that no matter how the money is received, i.e., lump sum, tenure payments, or some combination thereof, there is interest being charged that does accumulate on the growing loan balance - further reducing the ultimate equity remaining in the property.  Currently, on lump sum disbursements, the interest will be charged at a fixed rate dictated by the current marketplace.  Tenure payment loan interest rates will always be adjustable - tied to some selected financial index to allow for continuing changes in the marketplace over time.  In recent years, this rate has been varying between 4 and 6-1/2 percent.

No matter how large the interest accumulation on this loan becomes, because there is FHA required mortgage insurance, the amount payable to the borrower is guaranteed for their lifetime - even in the unlikely extreme example of long term declining property values coupled with longer than expected lifetime of the borrowers.  This set of circumstances has not happened yet.  That doesn’t mean that it won’t – it is just highly unlikely.

And even if the lender or bank disappears – which happens from time to time – as it did with First Magnus here in Tucson.  The FHA program ensures that the payments will keep coming – and will be made on time.  This was demonstrated surprisingly well after the Katrina disaster when some financial institutions were literally wiped off the face of the earth.  The FHA was able to pick up their obligation to make payments on the reverse mortgages which those financial institutions held, and made every payment – on time.  Well, there is at least one example of the Federal Government actually working properly for a change. 

So, in review:

-       All borrowers must be 62 years and older

-       No repayment is made until the home is sold or the owner permanently moves out or passes away

-       You will never owe more than the value of your home

-       No income qualification

-       Interest is paid at the time the loan is repaid

-       When the loan is due, your heirs have choices – they can repay the loan and keep the house, or sell the home and repay the loan

-       Social security benefits and Medicare are generally not affected by a reverse mortgage – consult appropriate government agencies

-       You own the home – the lender does not take control of the title

-       Interest rates are adjustable and can change periodically; however this DOES NOT affect the amount you will receive

-       Closing costs and fees incurred can be financed as part of the loan

-       You are free to do whatever you want with the money (it’s your money!)

Reverse mortgages often get a bad rap.  Some people believe that they unfairly take advantage of senior citizens.  Maybe that’s because they are still not well understood and probably more-so because before 1989 there were a lot of rip-offs with reverse mortgages.  Since then the laws have changed and it is a perfectly legitimate, safe and well regulated option for financial management when used appropriately.

Please note that this article was written by him to reflect the author’s opinion of good practice at the time of its’ writing for the general benefit of those considering sale or purchase of residential real estate, it is not intended as definitive legal advice and you should not act upon it as such without seeking independent legal counsel.  Frequent changes in the law and standards of practice may cause this information to become outdated and no longer applicable or even incorrect.