Reverse Mortgages Are A Real Good Thing For Your Cash
I’ve seen few things in my life as misunderstood or poorly understood as reverse mortgages, and the more I’ve learned about them, the more impressed I’ve become. In fact, I’ve come to like them so much that at 52, I’m almost looking forward to being ten years older so I can qualify.
Let me throw out a few things you can do with a reverse mortgage that most people don’t know or haven’t considered and I’m pretty sure you’ll see why I’ve become so enamored with what someone 62 years old and older can accomplish by using one.
First of all, when qualifying for a reverse mortgage your FICO score is almost irrelevant. Secondly, taking out a reverse mortgage does not mean that you’re losing all of the equity in your home after you die, so you won’t have anything to leave to your heirs. You retain title to your home and continue to be responsible for paying the property taxes and insurance, but you aren’t required to make any payments of principal or interest… unless of course you want to for whatever reason, in which case you certainly can.
The proceeds you receive from a reverse mortgage are not taxable, nor do they affect your Social Security or Medicare benefits in any way. In fact, there’s really nothing scary or risky about reverse mortgages, and if you’ve heard things like “they’re expensive,” which is what I had heard… well, in my opinion they’re just not. When you compare a reverse mortgage’s costs to other types of loans, there’s just not all that much of a difference.
I think the primary reason that many have heard negative things about reverse mortgages in the past comes from the days before they were so closely regulated… before they were almost exclusively under the purview of the U.S. Department of Housing and Urban Development or HUD, for short. Like all mortgage products, the way they are marketed and sold to consumers can make any type of loan a “bad loan,” so it’s always important to be doing business with reputable lenders.
Today’s reverse mortgages, at least the vast majority of them, are known as Home Equity Conversion Mortgages (HECMs), and their remarkable flexibility makes them a source of cash that can be received and used in all sorts of ways.
Check out the following ideas to see how you might consider using a reverse mortgage.
EXAMPLE #1: When you don’t have time to wait.
Let’s say that a retired couple’s home that had appraised for $1.2 million back in 2005, now appraised for only $800,000. They had always planned that after paying off their mortgage, they would sell the home and move to a more retirement friendly locale, like Florida for those on the East Coast, or Palm Springs for those in the West.
Now, however, with their home’s value having dropped by $400,000, they don’t want to sell it… they’d rather wait a few years in the hopes that they’ll see some appreciation in their home’s value. They feel like the downturn in the housing market has derailed their retirement plans, but a reverse mortgage can put them back on track by allowing them to have their cake and eat it too.
Based on their age, let’s say a reverse mortgage will allow them to borrow $300,000… so they do. And with that cash they go ahead and buy a condo by the beach or home on the golf course for $250,000… they use the remaining $50,000 to furnish their new place and to cover the costs of traveling back and forth to their original home, because they didn’t need to sell it… they just used it to secure their reverse mortgage.
Now they have two homes instead of one, but they have no monthly mortgage payments. Their retirement property is owned free and clear because they paid cash using the proceeds from their reverse mortgage, and their original home, although now it has a lien in the amount they borrowed, $300,000, still requires no monthly payment. If nothing else changes in their lives, then when the last spouse dies, the reverse mortgage’s lien will become due and it will consist of the principal amount plus interest and the mortgage insurance premium, which is standardized by HUD.
By that time, let’s say the home has appreciated and now appraises for $950,000 and their heirs decide that they’ll sell it. They’ll pay off the reverse mortgage, which after whatever number of years have passed now has a balance of let’s just say $400,000 including the interest and insurance premium… and the balance of $550,000 minus sales commissions becomes part of the estate… along with the free and clear beach condo or golf course home, of course.
Or, let’s say that five years after buying their second home, they notice that property values in their old neighborhood have recovered somewhat and their original home now appraises for $1 million. It’s not the $1.2 million they had once hoped for, but it’s enough for them at this point, because over the same years, their place at the beach or on the golf course has also gone up by $50,000.
So, the decide to sell their original home first, which means they’ll pay off their reverse mortgage as described above, and when that sale is completed, they’ll list their free and clear condo for $300,000 too. And once both properties have sold, they decide to upgrade to a much nicer retirement home, maybe one on the water with a dock… which they buy for $750,000 cash… leaving them with maybe a hundred grand or more, after all is said or done… who knows.
And once that sale has closed and they’ve moved into their retirement dream, they decide their dock doesn’t look right without a boat, but they don’t need to dip into their savings or take out a loan… at least not a loan that will require them to make monthly payments. They buy their boat, a beautiful 42 footer, using the proceeds of another reverse mortgage.
They went from feeling like their retirement plans had been derailed by the downturn in the housing market, to feeling like all of their dreams had come true. They have no monthly mortgage payment… and their boat is free and clear too… thanks to their reverse mortgage.
Are you wondering what they decided to name their boat? “Reversal of Fortune,” of course.
EXAMPLE #2: Remodeling without an Equity Line.
Another couple is only semi-retired, but he’s starting to spend a lot more time working from home instead of all the traveling he did for so many years. They’ve been in their home for 25 years, it’s near their kids, and they love it just as much as they did when they first moved in, but working from home reminds him of the things he hadn’t gotten around to doing… like putting in a pool and partially screened in deck… maybe an elaborate built-in bar and grill… an entertainer’s dream.
She thinks they should do it too… and maybe extend their kitchen a few feet at the same time, and wouldn’t he love to add a few feet to his study now that he’s using it as his office every day?
A few weeks later their looking at plans with their contractor, who says the whole job can be done for about $175,000, tax and tip included. The question is how do they want to pay for upgrading their home to their dream retirement resort?
They have retirement savings in various places like a couple of 401(k) plans, IRAs, some CDs and a few miscellaneous stocks, bonds and mutual funds… oh, and there’s the cash that’s accumulated in his whole life insurance policy. But all of those accounts are still recovering from the losses they took a few years back, and if they withdraw funds from retirement accounts there will be tax consequences to consider.
Someone suggests they get the funds through refinancing their mortgage… it would certainly be better from a tax perspective, but they’ve only got five years to go until it’s paid in full. And who wants to start all over with a new 30-year loan with only five years to go. So, they ask their bank about a Home Equity Line of Credit… that way, they can pay it down over time, still deduct the interest, and as they pay it off they’ll have the credit line available for emergencies.
A few years ago, opening a home equity line would have been a no brainer, but today they learn it’s a whole different story. Not many banks are even offering these types of loans anymore, the origination costs and interest rates are higher than he or she would have expected, but that’s not all… to qualify the bank says requires a FICO of at least 760. And the truth is, when the economy fell off a cliff five years ago, his business suffered for a couple years… along with his FICO score.
Then someone brings up the idea of using a reverse mortgage. Based on their age and equity in their home, they can borrow $200,000 no problem. In fact, they find out they can have up to $350,000, if that would make them more comfortable. The money would be tax free, and they wouldn’t have to make any payments on the loan… ever… unless they wanted to, in which case they could treat it just like they would have handled the home equity line.
Compared to the alternatives, it seemed almost too good to be true. It was like a $350,000 home equity line that you could decide never to pay a nickel on… or you could make whatever payments you wanted to… you could pay interest only… or you could pay down the principal. And even if they decided to pay nothing on the reverse mortgage loan, it wouldn’t come due until the death of the last surviving spouse, and its balance would be repaid out of the equity in the home at that time.
The origination fees were around two points, which was comparable to a second mortgage, and although there would be an annual mortgage insurance premium required, it was two percent a year, and would be financed into the monthly payments making it easily affordable.
They learned that reverse mortgages are federally insured so that upon the death of the last surviving spouse, were the property to be worth less than the amount of the loan, the home alone would satisfy the outstanding debt in its entirety, with any excess covered by the insurance.
Lastly, the adjustable rate loan meant that the interest rate was around 2.75 percent and since he felt comfortable that interest rates would not be rising quickly over the next several years as the economy continued its relatively slow recovery, both felt comfortable knowing they would always have the flexibility of refinancing or paying off the reverse mortgage with income or saved funds.
Clearly, the reverse mortgage was the only way to go. Not only would it finance their new backyard resort, along with their larger kitchen and new home office, but it would also leave them with a six-figure credit line that could be tapped for unexpected needs for cash, or never used. And all of it could be repaid… or not repaid until the death of the last surviving spouse out of the home’s equity, which by the way, would be increasing as a result of transforming their home into their own personal retirement paradise.
EXAMPLE #3: A couple suffering from terrible timing.
They bought their new home in 2006. Maybe there was a worse time to buy in our nation’s history, but if there was… well, no one could remember when that might have been. Then he had some health problems that turned semi-retirement into totally retired several years sooner than expected. And she was a Realtor, which for a couple of years meant she was almost unemployed. The whole thing felt like being hit by the perfect storm and now they were having trouble keeping up with their mortgage payments.
When they fell behind by a month, and then by two, the stress started mounting. They weren’t talking like they used to while at the dinner table and he was now having the occasional cocktail or two every night.
When they had bought the home for $550,000 it seemed like such a reasonable thing to do. Only a few years earlier homes in the development had been selling for $375,000… they thought getting in sooner would be better than later when the prices might make the home beyond their reach.
They were wrong… their home’s value was $250,000 on the always optimistic Zillow.com, which meant it was something less, and they owed $400,000… or maybe it was closer to $425,000… he couldn’t remember and didn’t even want to call his mortgage company to find out. Going on three months late on the payments, he was sure they’d be calling him soon enough.
Maybe he could get the loan modified, but even a modified payment would likely be almost impossible to cover at the moment… they needed time to catch up and recover, but in reality they needed to have spent less on their home. They had both worked their entire lives and done what they thought were the right things… he had his pension and his social security, but his savings had gone towards the down payment on the home… this was not how he expected retirement to go.
They called an attorney. Waiting in the lobby for their appointment, all he could think about was the word foreclosure… foreclosure… foreclosure. He turned down a glass of water when it was offered… he knew his hands were too shaky for that.
The lawyer suggested a reverse mortgage.
According to the lawyer, based on their age, and the appraised value of their home, they could borrow right around $200,000, and he would try to get their mortgage company to accept that amount as total satisfaction of their indebtedness. If all went well, not only would they not lose their home to foreclosure, but they’d have no mortgage payment for the rest of their lives. It just didn’t seem possible, and he could barely focus on what was being said.
The lawyer explained that since the home’s value had dropped in half… and maybe more… if the bank foreclosed and sold the home as an REO, they’d end up with less than the $200,000 they’d be offering to settle the debt. So, since there was no way the couple could pay the loan as agreed in light of their multiple hardships, the bank’s options were to either accept the $200,000 offer… or end up with even less.
But, the mortgage was way underwater… they had no equity. How could they get a reverse mortgage without having any equity? The lawyer explained that he would explain their situation to the bank, and since the couple definitely qualified for a reverse mortgage as far as their age, the bank would agree to remove the lien on the property to allow the reverse mortgage to go through and they would receive the proceeds.
The lawyer thought he might even be able to cut a deal that would leave the couple with some extra cash after the bank was paid in full. And they would never have to make a single mortgage payment for the rest of both of their lives. When the last surviving spouse passed on… the bank would get the house, and if there were any equity above and beyond the amount of the loan’s balance, their heirs could decide whether they wanted to refinance or sell the home… with any excess becoming part of the estate.
It was the reverse of what he had thought would happen when they had walked into the lawyer’s office only an hour ago… it was the reverse, all right… the reverse mortgage. It felt like a miracle.
You know how the story ended, right? It all worked out as planned and they lived happily ever after, of course.
Almost limitless possibilities… with limited costs.
The amazing thing about learning more about reverse mortgages is just how many possibilities there truly are for their use as a result of unparalleled flexibility. You can structure the payout of a reverse mortgage so that you receive equal monthly payments for life of both spouses. You can set it up to receive equal monthly payments for a fixed number of months. You can simply leave it open like a credit line and draw funds as you want to until the credit line is exhausted.
Or you can mix and match and arrange for part monthly payments and part credit line… it’s essentially like you can design your own reverse mortgage to fit your specific circumstances. And in case that’s not enough flexibility for you… you can change the set up anytime you want for something like a $20 fee.
Another thing about reverse mortgages that I found reassuring was that HUD caps the fees. Not all of them, so you do want to make sure what you’re being quoted is competitive, but most are the same from one lender to another and only FHA-approved lenders can originate these loans.
HECM reverse mortgages do have some important limits too, for example they cannot be based on an appraised value of more than $625,500. (And there are some private reverse mortgages, I’m told, that will accommodate higher priced homes.)
You’ll pay an origination fee for processing your HECM loan of up to $2,500 if your home is valued at less than $125,000… and if your home is valued at more than $125,000 lenders can charge 2% of the first $200,000, plus 1% of the amount over $200,000. However, HECM origination fees are capped at $6,000.
You will also be charged an initial mortgage insurance premium at closing… either 2% (HECM Standard) or .01% (HECM Saver) of the lesser of the appraised value of your home, the FHA mortgage limit of $625,500 or the sales price. Over the life of the loan, you will also be charged an annual MIP that equals 1.25% of the mortgage balance.
Lastly, there will also be some closing costs such as an appraisal fee, title search and insurance, along with fees for surveys, inspections, recording, mortgage taxes, credit checks, et al. And finally there will be a monthly servicing fee for the servicing of your reverse mortgage including things like sending you monthly statements and disbursing proceeds and the amount, which depends on whether your loan’s interest rate adjusts annually or monthly, will be no more than $30 – $35 a month.
Nothing else let’s you go forward like a reverse mortgage…I can’t think of anything that’s anything like a reverse mortgage. And the more I think about how they work and can be structured, the more uses for them come to mind. For example, one of the best and most important might just be helping to pay for the costs of a child’s or grandchild’s college education.
I realize that some homeowners might worry about a reverse mortgage decreasing the value of their estate, but compared with the life long impact of having to take out student loans into the six-figures, which as you might know cannot be discharged in bankruptcy, using a reverse mortgage seems infinitely preferable. And in a world where home equity lines of credit are difficult if not impossible to get… the idea of an open line of credit that you can tap into as you see fit for any reason and at any time, but that you never have to make a payment on… and today would be accruing interest at around three percent… well, why wouldn’t just about every single qualified homeowner want to have access to something like that whether they needed it or not?
I mean, it can’t be a bad thing to have an open credit line that never requires you to make a payment on borrowed funds, can it?