For elderly clients (and for the elderly parents of middle-aged clients), financial planners may want to consider reverse mortgages -- and the new rules recently put in place to protect borrowers.
"[Reverse mortgages] can be a very useful tool for seniors who plan to stay in the home for a long time,” says Jim Kinney, who heads Financial Pathway Advisors in Bridgewater, N.J.
As the name indicates, a reverse mortgage is the opposite of a conventional home loan. Borrowers usually get a reverse mortgage secured by the equity of the home in which they already live and plan to stay. Federally insured home equity conversion mortgages (HECMs) are the most common type of reverse mortgage and are available to homeowners age 62 or older who have little or no debt on their primary residence.
But Kinney also notes that such debt is not for everyone. “Some seniors were being sold reverse mortgages even though they did not have the resources to maintain the home,” he says. “When they needed to sell within a few years, they had to repay not only the money they had borrowed but also all of the interest and any closing costs that were added to the loan balance.” Such events disrupted borrowers’ lives and caused delinquency rates to spike, which in turn has resulted in some major lenders abandoning reverse mortgages.
Consequently, the Federal Housing Administration, which insures HECMs, recently has implemented new rules. Applicants now must undergo a financial assessment in order to qualify for a loan; lenders are required to make sure a borrower can pay for insurance, taxes, and home maintenance, based on the applicant’s assets and cash flow. In addition, the FHA has capped the first-year HECM payout to borrowers to 60% of authorized debt, down from 100% under prior rules.
Other changes went into effect this month. Now married couples can get a HECM even if one spouse is younger than 62 but a married applicant often can borrow less than had been the case. A couple aged 65 and 60 now might be limited to a loan of up to 51% of their home’s equity, for example, down from 54%. One reason for this tightening is yet another new rule: a surviving spouse who conforms to the loan terms can continue to occupy the house even if the spouse who died was the individual taking out the reverse mortgage.
SHIFT INTO REVERSE
“The great thing about a reverse mortgage,” says Kinney, “is that borrowers never have to make payments as long as they own and live in the home. However, the closing costs can be quite high. Therefore, reverse mortgages make sense for seniors who reasonably expect to be living in the home for at least five or 10 more years. If health or financial status makes that unlikely, using a reverse mortgage may not be the best strategy.”
For suitable borrowers, a reverse mortgage can provide a lump sum, monthly cash flow from the lender, or a line of credit—or a combination of those options. Even if there is no pressing need for cash, obtaining a reverse mortgage can play a role in a financial plan. “For seniors who are short on liquid funds for an emergency,” Kinney points out, “a HECM line of credit can be a lifesaver.”
His father's situation is a case in point. “My father had opened a home equity conversion mortgage (HECM) line of credit just a few months before Hurricane Sandy hit,” he recalls, “and his house was substantially damaged by the storm. The money available to him through the HECM line allowed my father to pay contractors and rebuild, even when payments from insurance companies and government agencies were being endlessly delayed. Once the insurance money came in, he was able to repay the line of credit. Thanks to the reverse mortgage, my father was able to get his house back into living condition much faster than many of his neighbors.”
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.