The poor economy and tight credit market has sent many of our retired clients scrambling for sources of cash to fund large expenses. Short of selling off investments or going back to work, there are a limited number of options. One option that has become popular recently is the reverse mortgage or home equity conversion mortgage (HECM).
The reverse mortgage or home equity conversion mortgage is a loan that lets you convert a portion of your home equity into cash. What distinguishes it from a typical loan is that you do not have to repay the loan until you no longer use the house as a residence. You or your heirs must repay the balance of the loan at time of death, move out or sale. If the amount owed is greater than the value of the house, the lender eats the difference. If less, then you or your heirs keep the equity left over after paying off the loan. You must be over 62 to qualify for a reverse mortgage. Also, you must visit with a Federal Housing Administration (FHA) approved reverse mortgage counselor. The counseling session can be done over the phone if a counselor is not available in your area.
For the house rich/cash poor borrower the reverse mortgage is an enticing source to pay off mortgages or other debt, pay health care bills or other everyday expenses, or fund home renovations. Banks, brokers and savings and loans are more willing to make these loans since the FHA insures up to 90% of the balance.
What makes reverse mortgages enticing for the borrower is the ease of obtaining these loans. Eligibility is based on age, home value and equity and not income or credit history. Another advantage is flexibility. The borrower can take the loan as a lump sum, regular payment, a line of credit, or some combination of the three. Also, the size of the loan can be rather large. Congress set the FHA maxim loan limit for reverse mortgages at $625,000 earlier this year and extended this limit through 2010.
While the reverse mortgage is a valuable opportunity for the borrower over 62 years old it doesn’t come without certain detractions. The biggest detraction is cost. Due to the FHA, insurance reverse mortgages can be more expensive than conventional mortgages. The upfront costs can exceed 10% of the loan. Another negative is that if the borrower opts to take the loan as a lump sum managing such a large amount of money can be difficult. Also, reverse mortgages are deferred debt and increase your debt load. This can leave you with little equity left in your house in your later years when you most need it.
Another concern regarding the reverse mortgage is that the market for these mortgages has taken on similar characteristics as those that existed with the sub-prime mortgage market. Some brokers use predatory and aggressive marketing tactics. Some of the practices include encouraging the borrower to use the funds from their reverse mortgage to purchase an annuity or some other financial product like long term care insurance. These brokers are probably trying to pump up their commissions rather than help your financial future, since such financial instruments are unlikely to earn you more than the cost of a reverse mortgage.
There are alternatives to the reverse mortgage, such as ordinary consumer loans, a home equity line of credit, or selling your home and purchasing a less expensive house. Such alternatives might not be as easy to obtain and come with costs you are unwilling to pay. The reverse mortgage is an enticing source of cash in this difficult economy and tight credit market; but it is important that before making any decisions you first discuss your options with your financial planner and look at the effects it will have on your entire financial picture. This is a great product for some, but can cause future problems for others. Below are some additional Web sites you can visit to gain additional information.
Tara Scottino, CFP®
Senior Vice President
Carter Advisory Services