- The Washington Times - Friday, June 19, 2009

The current economy has forced most Americans to take a hard look at their finances. Yet the most intense scrutiny comes from retirees or those who are contemplating retirement. Many seniors are considering a reverse mortgage as a way to bring in a lump sum or monthly income to supplement Social Security income, pay for medical expenses or make home improvements.

A reverse mortgage, available to homeowners age 62 or older with equity in their home, allows homeowners to convert the equity in their home to tax-free income without having to sell the home or take on mortgage payments. Even homeowners with a mortgage on the home may take out a reverse mortgage if they have enough equity in the property.

Homeowners who opt for a reverse mortgage must live in the home and pay upfront fees for the loan and insurance. The loan is repaid when the home is sold or when the owners pass away. If there is equity left over after the loan is paid, that equity will be returned to the owners (or their heirs).

Government-insured reverse mortgages, guaranteed by the Department of Housing and Urban Development’s Federal Housing Administration (FHA), are known as Home Equity Conversion Mortgage (HECM) loans and represent the majority of the reverse mortgage market.

New regulations, introduced as part of the Housing and Economic Recovery Act of 2008, raised the nationwide limit for reverse mortgages to $625,000. In addition, borrowers may now apply for a reverse mortgage for a home purchase, which may help seniors who want to downsize into a smaller home.

At first glance, these loans may seem like “free money” to homeowners with plenty of equity in their homes, but financial advisers recommend that homeowners consider all options before settling on a reverse mortgage. In fact, the FHA requires all reverse-mortgage applicants to receive consumer counseling from an approved housing counselor to be certain that the homeowners understand completely the implications of draining the equity from their home for current income.

“The counseling requirement stems from an automatic assumption that seniors are generally more vulnerable than others to financial scams, but we find that most people taking on reverse mortgages are quite savvy,” says Eric Bachman, founder and chief executive officer of Golden Gateway Financial, based in Oakland, Calif. “It is crucial for potential borrowers to understand the good and the bad of reverse mortgages.”

Reverse mortgages are negatively amortizing loans, which means that the amount of the money owed increases over time as interest accrues. The borrowers do not make payments during the life of the loan, so the interest continues to accumulate until the end of the loan.

FHA rules require that the total owed at the end of the loan cannot exceed the value of the property so that the owners or their heirs will not be required to make additional payments beyond the sale of the home. FHA reverse mortgages do not have a prepayment penalty, so the loan may be paid off at any time.

“Reverse mortgages are actually far more conservative than a forward mortgage, since the maximum that can be borrowed against a property is 55 percent of the value of the home,” says Mr. Bachman. “The amount borrowed is also typically dependent on the age of the borrower, so at age 65 the homeowner can only borrow up to 35 percent of the value of the home, rising to 55 percent only at age 85 and older.”

Golden Gateway Financial’s Web site (www.goldengateway.com) includes user-friendly calculators that can be used to understand the long-term implications of reverse mortgages in specific circumstances.

“I’m generally leery of reverse mortgages, particularly for younger seniors and for those who are in financial trouble,” says Barry Korb, a certified financial planner and principal of Lighthouse Financial Planning LLC in Potomac. “It is especially important that people not use a reverse mortgage for something unnecessary, such as a vacation. For most people, their house is their reserve, and eliminating that reserve eliminates the ability to use the equity for future emergencies, such as long-term care needs or a major maintenance problem with the home.”

Mr. Korb says he gets “nervous” when people attempt to pay their bills through fixed income such as a reverse mortgage, since bills tend to inflate.

“What happens if inflation hits or the borrowers have an unexpected expense?” asks Mr. Korb. “They have less flexibility with a reverse mortgage. This is especially significant with people on the younger side of their retirement years.”

Frank Boucher is a certified financial planner and owner of Boucher Financial Planning Services in Reston. He believes that under some circumstances a reverse mortgage might make sense, but that often other options are more financially advantageous.

“The key is whether or not the homeowners are adamantly opposed to leaving their home,” says Mr. Boucher. “In many cases, selling the home or taking out a traditional home equity loan can be a better option. But, for instance, if an elderly couple is determined to keep their home but one spouse needs to go to an assisted living facility, a reverse mortgage may be the only funding option.”

Mr. Boucher stresses that any kind of real estate transaction, including a reverse mortgage, should be part of an overall financial plan.

“It can be hard to leave the family home … [but] it may be better financially and for health reasons to sell a too-big home and take the cash to move into a home with fewer maintenance needs,” says Mr. Boucher.

Todd Harff, president of Creating Results LLC and co-founder of the International Mature Marketing Network, says that while an advantage of reverse mortgages is that they ensure that the homeowner cannot be evicted from the home, there are a number of considerations that should be evaluated before opting for one.

“A reverse mortgage can be a viable option if the homeowners are certain that they can age-in-place in the home and want to stay there until they pass away,” says Mr. Harff. “But often homeowners are not old enough to make that decision yet and may not realize the significant expenses and hassles that come along with maintaining a home as you age. The seniors also need to have significant equity in the home to make this worthwhile. I would hope that seniors would seriously consider other options such as active-adult communities, continuing care communities and senior apartments before opting for a reverse mortgage.”

Mr. Harff says that the new regulations allowing reverse mortgages for purchase may be of greater benefit to seniors.

“Using a reverse mortgage for a purchase presents new opportunities for people to relocate to a home that may be more appropriate for them as they age,” says Mr. Harff. “This can be an intriguing way to benefit from the equity in your previous home. The only downside is that some people rely on selling their home if they need additional help later on, such as moving into an assisted living facility. If they have a reverse mortgage on their new home, there may not be enough equity to fund such a move.”

Mr. Bachman explains a potential scenario for using a reverse mortgage for purchase this way: “In the past, homeowners would sell a $700,000 home and use $500,000 to buy a smaller home, leaving $200,000 to invest for living expenses. Now, the homeowners can sell a home for $700,000, put $300,000 into the home and take out a reverse mortgage for $200,000. This means that the homeowners would have $400,000 for living expenses between the unused equity and the reverse mortgage proceeds.”

Mr. Korb says that homeowners should look at a reverse mortgage as a “planning opportunity,” as long as they are careful with their budget.

“For instance, someone in this area can sell a home for $600,000 and then buy a place in North Carolina for $300,000 and take out a $200,000 reverse mortgage,” says Mr. Korb. “This means they have bought a house they can live in for life for only $100,000. But I would recommend that people wait a year after moving before taking out that reverse mortgage because sometimes people realize they don’t want to live in a new place after all.”

Homeowners with enough income and equity may prefer to consider a home equity loan rather than a reverse mortgage for expenses such as home maintenance or medical expenses, since the origination costs are higher on reverse mortgages. FHA-insured reverse mortgages have a service fee of 2 percent of the first $200,000 of home value and 1 percent of the amount above $200,000, capped at a maximum of $6,000.

Additional fees include closing costs and a mortgage insurance premium of 2 percent upfront and 0.5 percent monthly. Mr. Bachman says that interest rates on reverse mortgages are generally .25 to .50 percent higher than standard mortgage rates.

“A home equity loan has lower origination fees and can be tied to a specific amount for a specific need,” says Mr. Boucher. “The front end costs of a reverse mortgage get rolled into the loan, and if you end up not staying in the home for more than a few years, then the costs will not be worth it.”

An FHA-insured loan becomes due and payable when the owners die or when the home is sold, but it can also become due under certain other circumstances:

• You do not pay property taxes or hazard insurance or violate other obligations.

• You permanently move to a new principal residence.

• You, or the last borrower, fail to live in the home for 12 months in a row. An example of this situation would be if you (or the last borrower) were to have a 12-month (or longer) stay in a nursing home.

• You allow the property to deteriorate and do not make necessary repairs.

Reverse mortgage borrowers should be sure they understand the potential impact of such a loan on their rest of their finances.

“A reverse mortgage is a loan, not income, so there are no income tax impacts and the borrowers’ Social Security will not be impacted,” says Mr. Bachman. “There is a possibility of an impact on borrowers who are eligible for Medicaid, particularly if they have opted for a lump sum payment from the reverse mortgage. A counselor can help determine if this will be an issue, and sometimes simply switching to smaller payments will resolve the problem.”

Another consideration for reverse mortgages is the impact on the borrower’s heirs.

“If the homeowners die, then no payments are due for six months and the heirs can extend that by another six months, which allows them time to either refinance and pay off the reverse mortgage or to sell the property,” says Mr. Bachman. “Families need to have a conversation about the seniors’ finances to evaluate the impact of a reverse mortgage. Forty percent of people in their 40s and 50s are helping support their parents now, so the question is whether or not they want to be doing that, or having their parents take out a reverse mortgage and lose out on some of the equity in the home when they inherit the home?”

Mr. Bachman says that families need to make sure they understand all the negative and positive aspects of reverse mortgages, noting that the most important consideration is whether the seniors are certain they want to stay in the home. A reverse mortgage adds expenses and costs to the property that will have to be repaid if the owners decide to sell the home.

“From a strictly financial point of view, it might be best to sell the home and then downsize or rent,” says Mr. Boucher. “From an emotional point of view, if the homeowners really want to stay in their home, a reverse mortgage may be a solution to their needs. But they should be certain they understand their options before making that choice.”

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