Reverse Mortgages: A Wise Idea?
In a TV commercial, debonair actor Robert Wagner invites viewers to take a closer look at reverse mortgages. The former star of the series "Hart to Hart" offers a free DVD that explains how these mortgages work.
Cash-challenged seniors who want to stay in their own homes have kept reverse mortgages high on the public radar. But despite glowing testimonials from some customers, such as the ones on Wagner's DVD, not everyone thinks they're such a good idea.
In general, reverse mortgages, also known as home-equity conversion mortgages, turn equity into cash in several ways: monthly payments, lines of credit, one-time payouts or a combination. The amount homeowners can access varies according to their ages, home values, current interest rates and loan fees.
Reverse mortgages hit the scene in the 1960s, according to a 2005 report by the National Council on Aging. Although the public has been generally hesitant to embrace them, their popularity continues to climb. The number of federally insured reverse mortgages administered by the Department of Housing and Urban Development (HUD) rose from 43,131 the previous federal fiscal year to an all-time annual high of 76,351, a 77% increase, the National Reverse Mortgage Lenders Association reported recently.
Five of the top 10 reverse-mortgage markets are in California. Also on the list: New York City, Phoenix, Boston, Denver and Coral Gables, Fla.
Are reverse mortgages a wise idea? Most news stories imply they are. Reports suggest reverse mortgages can be a source of ready cash when it's needed, similar to other investments. But like anything that affects your bottom line when your earnings potential is limited, taking out a reverse mortgage isn't a no-brainer. That's why candidates for these mortgages should consider both the benefits and the drawbacks before jumping in. (See "Feeling wealthy can make you poor.")
Zoran Basich, an elder-law attorney and the operator of Nursing Home Solutions, a California company, says he believes reverse-mortgage lenders fail to give seniors the full story when it comes to cashing out home equity.
"What they don't tell you is . . . that the front-load is very high," Basich says. He says lenders like reverse mortgages because "these (loans) are very profitable to write in the short term."
Front-loading refers to upfront costs, paid out of the home's equity at closing. As with conventional mortgages, reverse-mortgage lenders make money the old-fashioned way: through interest, origination fees and points. The interest rate varies according to the market. However, closing costs are significantly higher with reverse mortgages.
In addition, borrowers continue to be responsible for real estate taxes, conventional homeowners insurance and home repairs, and have the added burden of paying for mortgage insurance, too.
Why would borrowers have to pay mortgage insurance? After all, that insurance is required for regular mortgages if borrowers don't have a large enough down payment, and its purpose is to protect lenders in the event of a default. With a reverse mortgage, there's no such risk to lenders.
But other risks exist. Mortgage insurance guarantees the lender will receive its full repayment. For example, a decrease in the property's value adversely affects the lender's reimbursement. Mortgage insurance also covers the lender in the event the mortgage is held over a very long period and accrued interest exceeds the value of the home.
It should be noted, though, that when it comes to a home appreciating in value, there is virtually no difference between conventional and reverse mortgages. The lender recovers only what it's actually owed. After the lender's loan, fees and interest are repaid, anything left goes to the homeowner or heirs.
Basich believes seniors should consider borrowing against the value of their homes only as a last resort. If there's no way around it, he says it's smarter to refinance as a 30-year fixed loan.
Here's how that would work: You own a home valued at $300,000. You find yourself in need of a large amount of cash for major home repairs and want a lump sum in the bank for future emergencies. You borrow a combination of cash and upfront costs (rolled into the loan) valued at $100,000 at 6%. Exclusive of taxes and insurance, you'd be repaying a little less than $600 per month on a 30-year loan. You wouldn't need mortgage insurance because you'd still have plenty of unencumbered equity.
The rub here is the monthly payments. However, Basich contends that the fees for this type of loan are lower, and your remaining equity isn't subject to interest or other costs associated with a reverse mortgage.
True, in a conventional mortgage, the money must be paid back starting right after closing, while reverse mortgages don't fall due until the home is vacated. But, Basich argues, because the payments on a conventional mortgage are stretched out over a longer period, they're lower and more manageable.
In the case of a reverse mortgage, younger borrowers can't cash out as much equity as older borrowers. To qualify for a reverse mortgage, you must be at least 62 years old. Because banks are repaid when the house is sold, it's quite possible a lender might have to carry the note for 20 to 25 years or more. For that reason, a 79-year-old is a much more attractive loan candidate from the bank's perspective.
As for the borrower, whether he lives six months or 30 years after the loan is closed, he still pays stiff upfront fees. Of course, statistically speaking, older borrowers are less likely to accumulate as much interest as younger ones.
The matter of Medicaid
Depending on where you live, Basich says, the proceeds from a reverse loan could prove a barrier to qualifying for Medicaid, which counts loan proceeds as an asset.
Although each state differs in the fine print, untapped equity in the home is not considered an asset in determining Medicaid eligibility, as long as it's owner-occupied. Recent federal legislation placed the home-exemption ceiling at $500,000.
For a homeowner with property worth more, there's definitely an argument for obtaining a reverse mortgage and then spending down the cash. But that cash is also subject to Medicaid's new time limitations on asset reduction. Talk to an eligibility specialist early in the process to see where you stand.
Additionally, Basich says, the terms of many reverse mortgages knock homeowners out of their homes after a period of absence, which varies from lender to lender. He says some reverse mortgages require the full loan balance plus accrued interest be repaid when the house is vacated by the owner for a specified period -- like a prolonged, but temporary, nursing-home visit. (See "Assisted living at your doorstep.")
"Can you imagine if you have nowhere to go to?" Basich says. "What incentive do you have to get better?"
Views of an advocate
Eric Tyson, the author of "Mortgages for Dummies" and other books about personal finance, tends to see reverse mortgages as valuable retirement tools when homeowners understand them.
A former financial counselor, Tyson says counseling -- mandatory before entering a reverse mortgage -- educates seniors to which lenders are reputable and which fall short.
"They should take their time, do their homework, do some reading about the topic," he says. "There's a lot of jargon and lingo they should get down."
Tyson agrees that fees associated with reverse mortgages run high. "That's usually the light-bulb moment for prospective borrowers," he says.
But, he adds, traditional 30-year mortgages also come with high price tags. Older people can find it more difficult to qualify for a mortgage because many retirees no longer work and have limited incomes. "People lose homes all the time when they default on their mortgage," Tyson says.
The majority of Americans rely on Social Security for their retirements. The problem is, there's often little to supplement Social Security -- except the home.
"What are you going to do with that equity? You can't take it with you," Tyson says.
Investigate all the options
George Downey, a former chairman of the Massachusetts Mortgage Bankers Association, says reverse mortgages are wonderful when used properly but shouldn't be considered a financial panacea.
"The first takeaway should be that every case is different and should be determined on a case-by-case basis," Downey says. Reverse mortgages make sense for some, but for others, there may be better solutions than tapping into home equity.
Downey says before committing to a reverse mortgage, take a look at other services available in the community. For instance, if a senior suddenly needs a lump sum amount to replace his home's heating system, home equity should not be the first resource to consider. Many power companies offer low-cost financing for heat, air conditioning and energy-conservation improvements. The local branch of the National Council on Aging is a great resource for other senior programs.
"In rural Massachusetts, we had an 83-year-old who needed to replace a furnace and some windows," Downey says. "She was doing a reverse mortgage and consumer counseling was required. They were HUD-approved counselors, totally independent of the transaction, there to make sure the senior knows what is going on and provide a system of checks and balances."
In this case, Downey says, one of the counselors was from the same small town and was aware of programs and grants available in the area. One program offered free furnaces to qualified individuals. She ended up with one and received some new windows at no cost.
"There are little pools of money around seniors that they are not aware of," Downey says.
He identifies yet another factor that may muddy the waters: the influence of other family members or caretakers who push the senior toward a reverse mortgage for selfish reasons, or counsel against it because they want to inherit the property intact. He advises anyone considering a reverse mortgage to take a good hard look at what other people stand to gain from the situation -- if anything -- while considering outside advice.
Boyce Watkins, a writer and finance professor at Syracuse University, says one often neglected aspect, and downside, of reverse mortgages can be the emotional impact.
"You're facing your own mortality," Watkins says. In addition, reverse mortgages affect where the homeowners live, how medical bills will be paid and what the future holds inasmuch as financial security is concerned. Most older adults nurture the idea of leaving something to their children and believe their home is sacrosanct. Parting with even a little of its value can be traumatic.
Watkins sees reverse mortgages as similar to secured credit cards. "It looks a lot like free money, and a lot of people miss the fine print," Watkins says. "Many customers only pay attention to two or three variables in a loan."
Watkins echoes Tyson's advice concerning the value of good counseling and takes it a step further. He says to talk to someone you trust, as well as a counselor, and ask "a zillion questions, such as 'What will happen if I get sick and go into a nursing home?' "
As Watkins points out, almost all of the downside of reverse mortgages can be weighed before moving forward. Read about them (the Federal Trade Commission has some good information). Also, get several quotes from reputable banks, understand the implications of ill health and find out how a reverse mortgage could affect Medicaid eligibility.
Ultimately, the decision is yours. Base it on what's right for your individual needs.