The Great Recession and stock market rout eviscerated retirement nest eggs, changing the course of retirement planning for millions of people. And while the value of real estate also plunged, many older Americans owned their homes outright, allowing them to utilize a reverse mortgage to help finance retirement. A reverse mortgage is a loan that allows homeowners 62 and older to convert a portion of the equity in their homes into cash, as long as the home remains their primary residence. Most reverse mortgages are offered through the Department of Housing and Urban Development and are guaranteed by the Federal Housing Administration (FHA) through a program called Home Equity Conversion Mortgages (HECM).
A reverse mortgagor must keep paying real estate taxes, utilities and hazard and flood insurance premiums. The amount you can borrow depends on several factors, including the age of the youngest borrower, the current interest rate, the appraised value of your home and whether the rate is fixed or adjustable. The more valuable your home is, the older you are and the lower the interest rate, the more you can borrow. In essence, a reverse mortgage can help retirees convert an illiquid asset — a house — into a liquid one that can help supplement retirement income.
According to the National Reverse Mortgage Lenders Association, since 1990, just over 900,000 people have tapped their home equity through a reverse mortgage. Because of the sharp decrease in the housing market, the number of seniors applying for these loans dropped by more than half last year (51,642) from 2009 and those numbers could drop even more with the announcement of new reverse mortgage application rules.
As of April 27th, the federal government has decided to make applying for a reverse mortgage more like the process for qualifying for a traditional mortgage. Prior to the change, reverse mortgages did not require lengthy underwriting process, but new borrowers will have to complete “financial assessment” tests.
Would-be borrowers must now prove that they paid their real estate taxes, homeowner association fees and other property-related charges on time for at least the past 24 months. Additionally, they will have to produce documentation, like tax returns, paystubs (if they are still working), bank statements and details of financial assets. Finally, reverse mortgagees will undergo a “residual income” analysis that examines their monthly expenses and cash flow.
If potential borrowers fall short, they may be required to fund a “life expectancy set-aside,” which would funnel a portion of the loan proceeds into a separate account and would ensure funding is available for future tax and insurance obligations. This is akin to escrow accounts on conventional mortgages, which are established to pay property taxes and homeowners insurance.
The set-aside amount is based on a number of variables, including: the total of current property taxes plus hazard and flood insurance premiums; the likely increase in tax and insurance costs; the expected average mortgage interest rate; and the life expectancy of the youngest borrower (the younger the borrowers, the higher the potential set-aside amount).
Critics say the new rules that will make it more difficult for consumers with low income or poor credit records to obtain reverse mortgages. But that’s just the point, according to regulators, who want to prevent defaults by extending reverse mortgages only to qualified borrowers. They note that borrowers with shaky financial situations may be better off selling their homes and using the equity to purchase another home or rent.
The new rules do not address the cost of reverse mortgages, but you should be aware fees can run 2 - 3 percent of the loan amount. It’s also important to remember that reverse mortgage payouts also can impact a borrower’s eligibility for means-tested benefits programs, like Supplemental Security Income (SSI) and/or Medicaid.
Fans of reverse mortgages note that the new rules preserve the ultimate benefit of the transaction: Borrowers can still receive a monthly check for life or get a line of credit insured to grow for as long as they live in the home. If you are serious about a reverse mortgage, consult a registered investment adviser or an attorney, who can help determine if it is in your best interest.