What is a reverse mortgage and when is it wise to consider getting one?
Posted May 2, 2019 10:42 a.m. EDT
I am not a financial planner by trade. I have always tiptoed carefully up to any topic involving money and the elderly. When it came to the concept of reverse mortgages, I’ve been especially hesitant. However, two local experts, Eric Colburn, a Certified Reverse Mortgage Professional at Alpha Mortgage, and Micki Schutte, RMF – Reverse Mortgage Funding, recently informed me that these have become a much safer and prudent option for certain cases, particularly for those in sudden need of significant amounts from retirement accounts for healthcare, house repairs, existing mortgage payoffs, or after the death of a spouse.
Colburn said the concept of reverse mortgages first arose as an idea in the 1960's as a way to help solve retirement challenges when people were mainly using pensions and 401K products. It was not until the late 1980’s during Reagan administration that the utilization of home equity conversion as a retirement tactic was realized.
“Reverse Mortgages have changed significantly since the government stepped into the arena in 2014 and put into place safeguards to protect the elderly from the subprime mortgage crisis of a decade ago,” Schutte said, adding, “They can be an especially wise choice for those paying income taxes on significant retirement account withdrawals.”
So, what is a reverse mortgage? Simply put, it is a way to extract equity in your home and turn it into cash. In a traditional mortgage, each month the balance of your loan and the interest you are paying on your loan decreases while the percentage of the equity in the house you own increases. In a reverse mortgage, the balance of your loan increases by what equity you take out. You still own the home, as with a traditional mortgage.
The big benefit, Schutte said, is the cash you draw out from a reverse mortgage, unlike the cash you draw out of a traditional retirement account, is tax-free. This can have enormous implications. Recently, Schutte worked with a client who suddenly needed 24/7 private care in her home. 24/7 agency care costs roughly $15,000/month in this region. Her client was withdrawing $12,000/month from her retirement, which catapulted her into a much higher income tax bracket. In fact, not only was she decreasing her 401k balance, she was also suddenly paying nearly $4,000/month towards income taxes.
FHA-HUD reverse mortgages are a government-backed loan program developed by the Federal Housing Administration (FHA), a member of the US Department of Housing and Urban Development (HUD). In 2014, after the housing market crash, the FHA restructured the program and enacted a series of consumer safe-guards or protection. The Non-recourse feature ensures that participants would never owe more than the current value of the house should they suddenly need to sell to move into residential care. For example, should the client mentioned above need to go into Assisted Living, if the housing market is down and the value of her house is less than the balance on the loan, she or her family can still sell the house at the current value, pay that amount towards the reverse mortgage balance and owe nothing more. FHA Private Mortgage insurance, which is required, would kick in and pay the rest and protect her or her family from the remaining balance. On the other hand, if the appraised value is higher than loan balance, they can still sell the home, payoff the loan balance and keep the proceeds.
How much of the appraised value is one entitled to? The government has developed a very specific formula based on the person’s age (life expectancy), the current interest rate and the appraised value of their home. This process helps ensure equity is left in the home near the end of use. While many different lenders offer a “FHA-HUD loan, called a HECM -Home equity Conversion Mortgage,” they are all required to use the same formula to calculate the amount. The interest rate may differ between Lenders.
More financial advisors are turning to these because increasing numbers of retirees have not saved enough money and do not have long-term care insurance. According to a May 2016 study conducted by the Center for Insurance Policy and Research, 52% of individuals turning 65 will have a high need for long term care over their lifetime.
What would prevent you from being eligible for a reverse mortgage? Qualifications are fairly simple. In NC, you must be 62 years of age, live in your home as your primary residence and have sufficient equity in the home to qualify. Colburn adds that it is generally not financially prudent if you intend to sell the house within the next three to five years.
The lender also does a financial assessment of applicants to make sure they have not fallen behind on their mortgage, their homeowner’s insurance, property taxes or HOA dues (if applicable) for the last two years.
There are six to seven trillion dollars of home equity that retirees have. Being able to tap into that for tax-free income, especially with unexpected care needs later in life, can be peace of mind for some.
Home Equity is often an overlooked retirement asset with 83% of older Americans sharing a concern over savings and retirement.
Schutte said of her client, “She was so relieved that she could sleep better at night again.”