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Broker's Opinion

Opinion and comments on general real estate practices and activity in Colorado Springs.

WHAT IS A REVERSE MORTGAGE?

Reverse Mortgages

Eligibility

To qualify for a reverse mortgage in the United States, the borrower must be at least 62 years of age and must occupy the property as his or her principal residence. In addition, any mortgage on the property must be low enough that it will be paid off with the reverse mortgage proceeds. Reverse mortgages follow FHA eligibility standards for property types, meaning most 1–4 family dwellings, FHA approved condominiums, and PUD's qualify. Manufactured housing qualifies based on standard FHA guidelines.

Before starting the loan process for an FHA/HUD-approved reverse mortgage, applicants must take an approved counseling course. The counseling is meant to protect borrowers, although the quality of counseling has been criticized by groups such as the Consumer Financial Protection Bureau.

In a 2010 survey in the United States, 48% of seniors cited financial difficulties as the primary reason for obtaining a reverse mortgage and 81% of seniors stated they would like to stay in the home in which they are currently living for the rest of their lives.

Loan size

The gross amount of money that a borrower can receive under a HECM reverse mortgage (i.e., a reverse mortgage insured by the federal government) is called the principal limit. The principal limit is based on the maximum claim amount, the age of the youngest borrower, and the expected average interest rate. The maximum claim amount is equal to the appraised value of the home or the maximum amount HUD will insure, whichever is less. At least through December 14, 2014, the maximum amount HUD will insure is $625,500. The maximum claim amount is multiplied by a principal limit factor to determine the principal limit. Principal limit factors are determined by HUD and are based on the borrower's age and the expected average rate of interest. The table below gives some examples of what the initial principal limit will be if a home is worth $250,000 and for borrowers of different ages and with different expected average rates of interest.

Borrower’s Age at OriginationExpected Mortgage Interest RatePrincipal Limit Factor (as of Aug. 4, 2014) Initial Principal Limit Based on a MCA of $250,000
655.5%0.478$119,500
657.0%0.294$ 73,500
755.5%0.553$138,250
757.0%0.373$ 93,500
855.5%0.644$161,000
857.0%0.479$119,750

Loan costs and existing liens may be paid from the principal limit. Other amounts for items such as taxes and insurance may also be subtracted from the principal limit. The result after subtracting these amounts is the net principal limit. This is the amount the borrower can actually convert to cash.

Interest Rate

Interest rates on reverse mortgages may be fixed or adjustable. Prior to 2007, all major reverse mortgage programs had adjustable interest rates. Adjustable rate reverse mortgages are typically adjusted on a monthly or annual rate up to a maximum rate. The note rate (or accrual) rate is used to calculate the interest added to the loan balance each month. The note rate may be different from the expected average interest rate used to determine the available loan proceeds.

Proceeds from a reverse mortgage

Cash from a reverse mortgage

The most common reverse mortgage is one in which the owner receives cash or a credit line from an existing home. The money from a reverse mortgage can be distributed in several different ways:

  • in a lump sum, in cash, at settlement;
  • as a cash payment (cash advance) every month, applied for a fixed term or for the owner's life
  • as a line of credit, similar to a home equity line of credit
  • some combination of the above.

Purchase of a new residence with "HECM for Purchase"

The Housing and Economic Recovery Act of 2008 provided HECM mortgagors with the opportunity to purchase a new principal residence with HECM loan proceeds — the so-called HECM for Purchaseprogram, effective January 2009. The "HECM for Purchase" applies if "the borrower is able to pay the difference between the HECM and the sales price and closing costs for the property. The program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction by eliminating the need for a second closing. Texas was the last state to allow for reverse mortgages for purchase.

Total Annual Loan Cost

The Truth in Lending Act requires lenders to disclose the Total Annual Lending Cost (TALC) for reverse mortgages. The TALC calculation should allow borrowers to compare the costs of the reverse mortgage from one lender to another. The specific formulas to calculate the impact of the factors listed above can be found in Appendix 22 of the HUD Handbook 4235.1.

Taxes and insurance

Unlike common practice in a standard mortgage, funds for taxes and insurance are not typically paid out of an escrow fund; they are paid directly by the homeowner. A lapse in either taxes or insurance could result in a default on the reverse mortgage.

The American Bar Association guide advises that generally,

  • The Internal Revenue Service does not consider loan advances to be income
  • Annuity advances may be partially taxable
  • Interest charged is not deductible until it is actually paid, that is, at the end of the loan.
  • The mortgage insurance premium is deductible on the 1040 long form.

The money received from a reverse mortgage is considered a loan advance. It therefore is not taxable and does not directly affect Social Security or Medicare benefits. However, an American Bar Association guide to reverse mortgages explains that if borrowers receive Medicaid, SSI, or other public benefits, loan advances will be counted as "liquid assets" if the money is kept in an account (savings, checking, etc.) past the end of the calendar month in which it is received; the borrower could then lose eligibility for such public programs if total liquid assets (cash, generally) is then greater than those programs allow.

When the loan comes due

The loan comes due when the borrower dies, sells the house, or moves out of the house for more than 12 consecutive months. The loan may also be declared due and payable if the borrower fails to pay property taxes or fails to maintain hazard insurance on the property. Once the mortgage comes due, the borrower or heirs of the estate have an option to refinance the home and keep it, sell the home and cash out any remaining equity, or turn the home over to the lender. If the property is turned over to the lender, the borrower or the heirs have no more claims to the property or equity in the property.

The lender has recourse against the property, but not against the borrower personally and not against the borrower's heirs. Thus the mortgage is within the category known as "non-recourse limit".

Volume of loans

Home Equity Conversion Mortgages account for 90% of all reverse mortgages originated in the U.S. As of May 2010, there were 493,815 active HECM loans. As of 2006, the number of HECM mortgages that HUD is authorized to insure under the reverse mortgage law was capped at 275,000. However, through the annual appropriations acts, Congress has temporarily extended HUD's authority to insure HECM's notwithstanding the statutory limits.

Program growth in recent years has been very rapid. In fiscal year 2001, 7,781 HECM loans were originated. By the fiscal year ending in September 2008, the annual volume of HECM loans topped 112,000 representing a 1,300% increase in six years. For the fiscal year ending September 2011, loan volume had contracted in the wake of the financial crisis, but remained at over 73,000 loans that were originated and insured through the HECM program.

Loan volume is expected to grow further as the U.S. population ages. The U.S. senior population is expected to increase from 35 million in 2000 to 64 million in 2025, and seniors are expected to make up a larger share of the population.

Criticism

Reverse mortgages have been criticized for several major shortcomings:

  • High up-front costs make reverse mortgages expensive. In the U.S., entering into a reverse mortgage will cost approximately the same as a traditional FHA mortgage.
  • The interest rate on a reverse mortgage may be higher than on a conventional "forward mortgage".
  • Interest compounds over the life of a reverse mortgage, which means that "the mortgage can quickly balloon". Since no monthly payments are made by the borrower on a reverse mortgage, the interest that accrues is treated as a loan advance. Each month, interest is calculated not only on the principal amount received by the borrower but on the interest previously assessed to the loan. Because of this compound interest, the longer a senior has a reverse mortgage, the more likely it is that most or all of the home equity is depleted when the loan becomes due. That translates to "less cash for your estate or to pay your bills. That said, with the FHA-insured HECM reverse mortgage, the borrower can never owe more than the value of the property and cannot pass on any debt from the reverse mortgage to any heirs. The sole remedy the lender has is the collateral, not assets in the estate, if applicable.
  • Reverse mortgages are confusing. Many seniors entering into reverse mortgages don't fully understand the terms and conditions associated with the loans, and it has been suggested that some lenders have sought to take advantage of this. 46% of seniors understood the financial terms of reverse mortgages very well when they secured their reverse mortgage. "In the past, government investigations and consumer advocacy groups raised significant consumer protection concerns about the business practices of reverse mortgage lenders and other companies in the reverse mortgage industry" but in a 2006 survey of borrowers by AARP, 93 percent said their reverse mortgage had a mostly positive effect on their lives, compared with 3 percent who said the effect was mostly negative. Some 93 percent of borrowers reported that they were satisfied with their experiences with lenders, and 95 percent reported that they were satisfied with the counselors that they were required to see.

*Information on the above article was used from Wikipedia, some information and figures may have changed.

Reverse Mortgages are complex, have conditions that must be met yearly, and requires an approved counseling course.

Mark Potter; GRI, SRES, CNE, e-Pro, MBA

January 2015 

www.PotterPartners.com

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