Reversing the Course on Reverse Mortgages

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1 Reversing the Course on Reverse Mortgages A Primer for Financial Planners connect@reversevision.com

2 Executive Summary Historically, seniors with home equity may have considered home equity loans or lines of credit (HELOC) if they lacked significant savings to tide them over until they could make penaltyfree IRA withdrawals or draw their full Social Security retirement benefits. However, for those seniors that want to continue to age in place (i.e. continue to live in their home as they age), the reverse mortgage product makes far more sense. According to data released by the National Reverse Mortgage Lenders Association and RiskSpan Advisors, seniors home equity increased by $59.1 billion in Q4 2014, marking the 11 th consecutive quarter of increased home equity for seniors. RiskSpan also estimates the value of senior-owned housing at $4.98 trillion, the highest level seen since before the financial crisis. 1 While reverse mortgages have historically been viewed as risky, recent regulatory changes, as well as an increased understanding of their purpose, have made reverse mortgage a much more attractive option for financial planners as part of an overall retirement funding strategy. In a Dec. 1, 2014 article on The Wall Street Journal Web site titled The Case for Reverse Mortgages, Wade Pfau, a professor of retirement income in the Financial and Retirement Planning Ph.D. program at The American College, sums it up nicely: Reverse mortgages have received a bad reputation, but recent research has demonstrated how financially responsible individuals can improve their retirement sustainability with a reverse mortgage. The issue is that financial services are still mostly focused on wealth accumulation, and there is still a need for greater recognition about how retirement income requires a whole new host of tools as people seek to transform their pot of assets into an income for life. This is especially true for individuals who hold a disproportionate amount of their overall wealth in the form of home equity. What a reverse mortgage can do is to increase a retiree s flexibility to meet spending objectives by integrating an otherwise illiquid asset into an overall framework for how to best spend down assets in retirement. Given the product s changing reputation and recent regulatory changes that have added another layer of security, now may be the time for financial planners to reverse course on reverse mortgages. 1 National Reverse Mortgage Lenders Association, RMMI Increases 11 Consecutive Quarters, March 23, 2015, 2

3 Reverse Mortgage 101 For the uninitiated, a reverse mortgage is a mortgage product that enables homeowners aged 62 and older to borrow against the equity in their homes. Unlike a traditional forward mortgage where the homeowner has to make regular monthly payments towards the loan, reverse mortgage holders actually receive money from the lender in one of several ways: a lump sum, a fixed monthly disbursement, withdrawals from a line of credit or a combination of all three. 2 There are two main categories of reverse mortgages: Home Equity Conversion Mortgages (HECMs) and non-hecms. HECM Reverse Mortgages Most reverse mortgages fall into the HECM category and are insured by the Federal Housing Administration (FHA). When applying for a HECM, borrowers may choose from the following options: 1. Frequency of payment (lump sum, monthly payments, etc.) and 2. Type of interest rate (fixed or adjustable) In regards to payment, the best options are a line of credit or monthly disbursement because these options allow the borrower to access the most of their home s equity. The traditional view of taking a lump sum reverse mortgage has fallen out of favor with many financial planners and retirement experts. For instance, Jamie Hopkins, J.D., LLM, CLU, RICP, The Associate Director of The New York Life Center for Retirement Income, states, The line of credit option has become the go-to reverse mortgage payment system because of one s ability to only tap into your home equity when you need it and for the exact amount that you need. In a lot of ways, the biggest issue with a lump sum payment is that the homeowner might have trouble managing the money and meeting his or her needs. The line of credit and income stream options take a lot of that mismanagement risk away from the individual. Though it seems counterintuitive to anyone with a traditional mortgage, the adjustable rate HECM is actually preferable over the fixed rate from a financial planning perspective. Here s why: The rationale for preferring fixed rates on standard mortgages, which is to avoid the risk of a payment increase, has no applicability to reverse mortgages, which have no required payment. [It s important to note here that there is a risk with an adjustable rate HECM. That risk is incurring significant additional cumulative interest rate charges over the lifetime of the loan, should interest rates rise. However, that risk does not include overdrawing the available funds. When considering a HECM as part of a financial 2 National Reverse Mortgage Lenders Association, Reverse Mortgage Basics, 3

4 retirement plan, financial planners should discuss with their clients the impact interest rate fluctuations could have on their estate.] The benefit of the fixed rate on a reverse mortgage is only that the borrower knows in advance exactly how fast the debt secured by his home will grow. The downside is that the fixed-rate HECM offers only one way to draw funds, which is to take a lump sum at closing. The fixed rate HECM reverse mortgage is primarily for seniors who plan to use all or most of their borrowing power right away. Their intent is to pay off an existing mortgage, buy a house, purchase a single-premium annuity, or transact for some other purpose that requires a large and immediate payment once it is closed, no more funds can be drawn. The only way the senior can draw more funds is to refinance the HECM into a new HECM, but for that to work, either the value of the home would have to rise appreciably, or regulations that cap draw amounts would have to be relaxed. The adjustable rate HECM allows seniors to draw funds at closing, and also to draw funds after the closing. Such borrowers are able to plan for their future in a way that those who take a fixed-rate cannot. Adjustable rate borrowers can draw a fixed monthly payment for a specified period, or for as a long as they reside in the house; they can draw cash irregularly as needed; and they can let their borrowing power sit as an unused credit line indefinitely. The unused line grows month by month at the same rate as their debt, so that the longer they wait before drawing on the line, the larger is the line further, they can adjust their options in the future as their needs change. 3 In addition to the standard HECM, there are also two special-use HECMs. For older homeowners that maybe want to downsize or relocate, the HECM for Purchase product allows them to purchase a home with the proceeds of the reverse mortgage loan. The HECM for Purchase is often over-looked or simply not known in the traditional loan space. However, this product could make all the difference for borrowers looking to downsize and have no mortgage payment. In addition, HECM borrowers may convert their existing HECM into another HECM loan through the HECM Refinance product. This allows borrowers to take advantage of lower interest rates or access their home s increased equity. 3 The Mortgage Professor, The Fixed Rate Versus Adjustable Rate Decision: Standard Versus HECM Reverse Mortgages, Jan. 12, 2015, %20Reverse%20Mortgages/adjustable_rate_versus_fixed_rate.html 4

5 Non-HECM Reverse Mortgages Many entities, such as state/local governments and non-profits, will offer single-purpose reverse mortgages, which can only be used for the purpose specified by the lender. Typically offered in certain areas for low- to moderate-income borrowers, this type of non-hecm reverse mortgage is used, for example, to make home repairs or to pay property taxes. As a non-hecm product, these single-purpose reverse mortgages are not federally insured. In addition, some reverse mortgage lenders offer proprietary reverse mortgages. These products are typically designed for borrowers with high-value homes are also not federally insured. A reverse mortgage can help one tap into their home equity without having to give up their current living situation. However, a reverse mortgage should be part of an overall retirement income plan, said Hopkins. A bad reverse mortgage is one that is not done in coordination with other retirement goals and objectives. If downsizing is a better option because it allows the person to not only tap into home equity but move to a more elderly friendly community, it should be considered. 5

6 Addressing the Issues with Reverse Mortgages Due to the some negative press surrounding reverse mortgages, many financial planners are reluctant, if not outright resistant, to including the product as part of an overall financial retirement strategy. However, much of that reputation is due to a lack of understanding of the particulars of a reverse mortgage, as well as media representation of the worst case outcomes. The fact is most reverse mortgage borrowers are very satisfied with their loans. Between 2011 and 2014, approximately 260,000 HECM loans were originated and endorsed by the Department of Housing and Urban Development (HUD), FHA s parent agency. Based on information from the Consumer Financial Protection Bureau s (CFPB) complaint database, there were only 1,200 HECM complaints registered during that period, representing just 0.5 percent of the total volume. To increase financial planners familiarity and overall comfort level with the reverse mortgage product, here are responses to some common reverse mortgage concerns. Reverse mortgages are expensive. Yes, reverse mortgages are more expensive from a fees perspective than other types of home equity products, but the reality is that all mortgage products come with fees. Origination fees are how borrowers compensate mortgage companies for their work in originating the loan. There s also a cost to service the mortgages with keeping information on the loan current and processing transactions after the loan has closed, and the borrower must pay those costs. What financial planners and their clients should take into account is those up-front fees versus what s required to repay the loan. What s important to remember is, with a reverse mortgage, there is no required monthly payment. That alone makes the reverse mortgage product more compatible for retired homeowners from a liquidity perspective. Reverse mortgages cheat a borrower s heirs out of the family home. The main payoff mechanism for a reverse mortgage is to sell or refinance the home after the homeowners have passed or are no longer using the home as their primary residence (heirs can also pay off the reverse mortgage with cash if they prefer). They are given up to one year to payoff the outstanding balance on the reverse mortgage. The heirs are protected from ever owing more than the value of the house at time of sale as a result of the FHA mortgage insurance required on all reverse mortgages. HUD would potentially order an appraisal at time of sale to confirm that the home is being sold at fair market value. Ultimately, taking out a reverse mortgage as part of a financial retirement plan isn t something that should occur in a vacuum. Heirs need to be included in the decision making process so as to avoid any surprises down the road. The surviving spouse loses the home upon the death of the borrowing spouse. 6

7 Many seniors take out a reverse mortgage as soon as one spouse comes of age. Others only put one spouse on the loan to increase the chances of qualifying. Thus, when the borrowing spouse dies, the surviving spouse, who is not listed on the reverse mortgage, is unable to retain the home unless they payoff the loan. This type of scenario is where having a financial planner involved in the process can make all the difference, as Michael Kitces, partner and director of planning research with Pinnacle Advisory points out: Almost by definition, this is really only a relevant strategy when the loan is being used as a last resort, where a couple must leave a spouse off the loan because they re so desperate there s no other way to borrow the absolute utter maximum they re trying to get under a single-spouse situation. Generally speaking, financial planners generally aren t working with clients already in a last-resort situation, and the whole point of planning is to try to minimize ever putting clients in such a situation in the first place. From a regulatory perspective, HUD has addressed this concern by issuing guidelines for lenders to defer foreclosure upon the death of the borrowing spouse, thereby allowing the non-borrowing spouse to retain the home, though, there are specific requirements the non-borrowing spouse must meet in order to defer foreclosure. However, it is imperative that financial planners educate their clients about the downsides of leaving a spouse off a reverse mortgage and steer them in a direction that provides for a much more secure retirement future. 7

8 New Rules Make Reverse Mortgages Safer than Ever Over the years, the media has highlighted story after story of senior homeowners done wrong by unscrupulous reverse mortgage lenders. Unfortunately, the actions of a few have caused reverse mortgages to be viewed with disdain and mistrust by those not fully educated about the loan. Part of what has contributed to reverse mortgages historically poor reputation was the previous lack of regulation, which allowed bad actors to take advantage of distressed retirees. Fortunately, that is no longer the case. Today, reverse mortgages are highly regulated by the Department of Housing and Urban Development (HUD), among other entities. Most recently, HUD announced that it will require all reverse mortgage lenders to conduct a Financial Assessment on potential reverse mortgage borrowers to evaluate the mortgagor s willingness and capacity to timely meet his or her financial obligations and to comply with the mortgage requirements. For those reverse mortgage borrowers who do not meet these requirements, full or partial life-expectancy setasides will be required. These new regulations will force some reverse mortgage companies to change the way they have done business in the past. While new regulations err on the side of safety, they could also exclude some low-wage and -wealth individuals that would have otherwise benefited from a reverse mortgage. However, if the new rules can overall strengthen the industry by providing more safety to homeowners, it could help drive more people to better utilizing a reverse mortgage as a part of a successful retirement plan. What this means for the reverse mortgage product is that there are even greater assurances in place that borrowers are utilizing the reverse mortgage product responsibly and aren t relying on it as a financial means of last resort. When testifying before the Senate Committee on Aging in 1969, UCLA profession Yung-Ping Chen had this to say about the purpose of the reverse mortgage: I think an actuarial mortgage plan in the form of a housing annuity can serve two purposes: First, to enable older homeowners to realize the fruits of savings in the form of home equity; and second, to enable those homeowners, who wish to remain in their homes either for physical convenience or for sentimental attachment, to do as they wish. HUD s FA rule more closely aligns today s reverse mortgage products with Chen s vision, as well as the program s intended purpose when then-president Ronald Reagan signed the Home Equity Conversion Mortgage Demonstration Act into law in As Randy Davis, CRMP and assistant vice president of reverse lending at Dollar Bank recently pointed out, I ve always taken the position that what s in the best interest of the customer is also in the best interest for the bank or the lender. I don t want to set somebody up in a reverse mortgage that is not going to be able to pay their taxes because in two or three years, they may 8

9 find themselves in danger of foreclosure. The point of a reverse mortgage is to keep the borrower in the house. From Davis s point-of-view, Financial Assessment transforms the loan originator into more of a quasi-financial advisor. We want to make sure if a borrower gets a reverse loan that it s a long-term, he added. If the Financial Assessment shows them that they re not going to be able to pay the taxes and insurance, maybe that borrower needs to do something else. Sell the house, move in with the adult children, or sell the house and rent something. Unfortunately, not everybody should have a reverse mortgage. 9

10 When Does a Reverse Mortgage Make Sense? From a financial planning perspective, a reverse mortgage can be a useful tool in bridging the gap between a client s retirement and the age in which they are eligible to fully access other financial retirement resources without penalty. For example, those with IRAs as part of their retirement strategy can begin making withdrawals after age 59 ½. However, withdrawals made are subject to state and federal taxes, whereas reverse mortgage funds are not. Those factoring in Social Security benefits into their retirement strategy would also be well advised to consider a reverse mortgage at age 62 to avoid a reduction in Social Security retirement benefits. The Social Security Administration s (SSA s) full retirement age is 66, soon to be 67, but seniors can start receiving benefits as early as 62. However, those benefits would only be paid at 75 percent of what they would be if taken at full retirement age instead. For spouses receiving their partner s benefits, the payout at 62 would only be 32.5 percent versus 50 percent if taken at age 66. In this case, a reverse mortgage would allow a senior, or their spouse, to postpone taking SSI benefits until reaching full retirement age. HECM v. HELOC Home equity is one of the best sources of bridge funding for retiring homeowners. Of the mortgage home equity products available, the Home Equity Line of Credit (HELOC) is far better understood and leveraged more frequently. However, the Home Equity Conversion Mortgage (HECM) is equally as useful and can be another option for seniors to tap into their hard-earned home equity to help fund their retirement. One unique selling point to the HECM reverse mortgage product is that the loan is insured by the Federal Housing Administration (FHA), which means that neither the borrower nor their estate is responsible for making up the difference should the debt exceed the home s value. In addition, HELOCs often require the borrower to continue to draw on the line in order to keep it active, whereas HECMs do not. Borrowers can use (or not use) funds whenever they like and are not penalized for simply letting the line remain open and unused. Furthermore, HECMs can provide additional opportunities for line of credit growth not available with the HELOC product. By taking out a HECM at age 62, the borrower s line of credit grows along with the current expected interest rates, potentially making more money available to the borrower over the life of the HECM. Monthly payment requirements are also a key difference between HECMs and HELOCs. In addition to making monthly payments, borrowers typically must repay HELOCs within 10 years, or face a dramatic interest rate increase on the outstanding balance. A rate reset on a HELOC can potentially double the monthly payment, and for seniors on a fixed budget, that increase could significantly impact their quality of life, perhaps setting the stage for a loan default. Conversely, there is no such fixed repayment date on a HECM. For as long as the borrower lives in the home on which the loan is secured, they have access to those funds, and the balance of the 10

11 loan is not due until the borrower passes, moves or sells the home. While the interest rate may fluctuate with an adjustable rate HECM, those fluctuations only affect the outstanding balance of the HECM, not the funds available. As Hopkins stated, One of the best uses of a reverse mortgage is the line of credit option, which with today s low interest rates, and the likelihood that they will rise over time, could create a scenario where the line of credit could be worth more than the home as the line of credit grows at a variable rate. 11

12 Reverse Mortgage Resources for Financial Planners HECMs are complex financial tools, and for the uninitiated, they can prove challenging to understand and explain accurately. One of the best ways to overcome the stigma associated with HECMs is to better educate yourselves and your clients on what options are available. Leading reverse mortgage loan origination system (LOS) provider ReverseVision offers an online education resource called RV University has become the de facto standard for HECM training for reverse mortgage lenders nationwide. Here, you can find the tools to gain a better understanding of the HECM product and how it can fit in to a more holistic financial retirement strategy. In addition, the National Reverse Mortgage Lenders Association (NRMLA) offers numerous educational resources on its Web site ( The organization also offers a certification program for reverse mortgage lenders and can help connect you with a Certified Reverse Mortgage Professional (CRMP) in your area. 12