Reverse mortgages have taken heat, and often rightly so, as risky, expensive financial products. But in 2014 the federal government changed rules for those loans, adding a number of safeguards. With the improvements, reverse mortgages are a better tool for seniors who need to shore up financially shaky retirements.
The need is huge
Reverse mortgages aren’t selling like hotcakes at the moment. But that could change as broke baby boomers advance in age. These three figures explain why:
- $6 trillion: That’s the amount of home equity belonging to Americans 62 and older in 2016, according to the National Reverse Mortgage Lenders Association, an industry trade group.
- $12,000: That is the median retirement savings of Americans who are near retirement age, according to the the National Institute on Retirement Security. The institute adds: “The average working household has virtually no retirement savings.”
- $6.8 trillion to $14.0 trillion: This is the institute’s estimate of the gap between the savings Americans need for retirement and what’s actually in their retirement accounts.
So what that means, in short, is that many people have money tied up in their homes that they may quite desperately need to support them through retirement. A reverse mortgage gives the borrower a way to free up that equity and spend it.
Reverse mortgages are loans available to homeowners age 62 and older. The home is the collateral. Unlike a typical fixed-rate mortgage, they usually carry a variable interest rate that can change with time. The fees tend to be high, as do interest rates.
Borrowers withdraw some of their home’s equity without paying it back until the point when they or a widowed spouse leave the home, dead or alive. Then, the lender takes over ownership or the home’s heirs pay off the loan, buying it back.
Reverse mortgages enjoyed a boomlet in the years before the financial crash of 2008 when lenders were selling them at the rate of about 100,000 per year, says Jon McCue, client relations director of Reverse Market Insight, which gathers, sells and publishes data about the reverse mortgage industry.
Sales have plummeted
But the crash, along with a history of lax lending requirements, got many borrowers into financial trouble. By 2012, research shows, nearly a tenth of the federally insured Home Equity Conversion Mortgages (HECM) sank into default because the borrowers couldn’t pay their property taxes or homeowners insurance.
Just half that many reverse mortgages are sold today, McCue said in a phone interview. Why the drop? A stronger economy and lower interest rates play a role. But Congress played a part, too, by authorizing the Federal Housing Authority to tighten reverse-mortgage lending. The 2014 rule changes have made the loans safer but harder to obtain and less desirable for many would-be borrowers.
The rule changes haven’t eliminated all the problems. But they have made reverse mortgages safer in these four ways:
1. Borrowers now must qualify
The rule that borrowers must qualify financially applies to the government-insured HECM loans. Lenders scrutinize borrowers’ income and credit history to ensure that they can continue paying the home’s property taxes, insurance and HOA fees. Those who flunk the financial standards still may be able to borrow but they must set aside some of their borrowed funds to cover those obligations.
This rule has made the loans significantly safer. “During those high levels of volumes, one of the benefits to reverse mortgage was, you didn’t have to qualify financially,” he says. “But what that led to was taxes and insurance defaults. And evictions. Nobody wants that. I don’t know any lender who wants that to happen. It’s not good for the industry, it’s not good for the business.”
2. You can’t get the money in one check
As before, borrowers can choose one of two ways to get their loan money — as a line of credit or a lump sum.
Previously, borrowers could get their hands on their entire loan amount immediately. Borrowers now can receive only up to 60 percent of their loan amount in the first year. Here’s the exception, according to the federal Consumer Financial Protection Bureau:
If the amount you owe on an existing mortgage (or other required payments) is more than 60% of this limit, you can take out enough to pay off your mortgage (and any other required payments, including upfront loan fees) plus cash of up to 10% of the initial principal limit.
3. An age requirement is lifted
HUD used to require both borrowers and “non-borrowing” spouses whose names are not on the loan papers to be at least 62. No longer. Now, borrowers can qualify for a reverse mortgage with a spouse of any age. That’s a good-news-bad-news change. Putting a younger borrower on the loan means you’re able to borrow less of your equity since the loan is likely to be a longer one, exposing the lender to more risk. Today, “the size of a married couple’s payout (calculated using actuarial tables) will be based on the younger spouse’s age, even if that person isn’t on the mortgage’s title — the younger the person, the smaller the loan,” Next Avenue explains.
4. Eviction protection for widows and widowers
Until a 2014 HUD rule change, a reverse mortgage had to be repaid when the borrower died. That often meant lenders evicted elderly widows and widowers whose names weren’t on their home’s loan documents.
Because older borrowers typically were allowed to withdraw more money than younger ones, before the rule change couples could get more money by keeping a younger spouse’s name off the loan documents.
But lenders must make delicate calculations about how much money to loan. If they don’t correctly estimate how long a borrower will keep the loan, interest and fees can build up to where the debt surpasses the home’s value, a losing proposition for the lender.
The new rule requires lenders to let the spouse of a borrower who dies or goes to assisted living stay in the home as long as the spouse keeps up taxes, HOA fees and insurance and makes it their permanent residence.
The rule also requires lenders to base the amount borrowed on the age of the youngest spouse, whether or not that spouse is a borrower. This requirement, which means that couples with a younger spouse receive a smaller loan, also has put a damper on reverse mortgage lending.
Proceed with caution
The new rules make reverse mortgages a somewhat safer tool for people who are in serious need of financial help in retirement.
But these loans remain considerably more expensive than a traditional mortgage. The fees are high and the interest rates, especially for an adjustable line of credit, can be very high. Try using the National Reverse Mortgage Lenders Association’s calculator to estimate your loan size and costs.
There are other reasons for to approach these loans very carefully. As the National Council on Aging puts it:
Reverse mortgages themselves are not a scam, but there are unscrupulous people and companies that sometimes use reverse mortgages to exploit consumers. The FBI and U.S. Department of Housing and Urban Development (HUD) urge vigilance when looking at reverse mortgage products.
Fortunately, if you apply for a reverse mortgage, you must receive loan counseling from a nonprofit agency. That’s a good thing. As we all know, making something safer doesn’t mean you still should not proceed with caution.
To learn more about how reverse mortgages read:
- “Ask Stacy: Should I Take Out a Reverse Mortgage?“
- “Looking at a Reverse Mortgage? Explore These 14 Alternatives First“
- “5 Ways Scammers Are Going After Grandma’s Money“
- “Beware the Sugar-Coated Reverse Mortgage“
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