by E.A. Roberts
The credit crisis has reached epidemic proportions. Homes with adjustable rate mortgages are being foreclosed on, parents are now beginning to have difficulties obtaining student loans, and home equity loans are becoming the next serious trouble spot looming on the horizon. In consequence, the nation is now spiraling into a recession with the value in homes plummeting. Banks are tightening credit requirements, with everyone holding their breath to see how bad things are going to become.
Interestingly enough, home equity loans, also known as reverse mortgages, have become a recent hot topic of conversation locally. An article appeared in the March 27, 2008 Davis Enterprise, with the headline, “Are home equity loans next round in credit crisis?”. Yet paid advertisements on the subject have been materializing within the pages of the same newspaper, with the caption, “Yolo County Seniors Discover Simple New Way to Solve Nagging Money Problems!” By the way, the words “Paid Advertisement” appear in very small print at the top of these ads, which many seniors would have difficulty reading.
- all at once in a lump sum (which can be used to pay off an existing mortgage; or an annuity can be purchased);
- regular monthly cash advances:
- Tenure - equal monthly payments as long as borrower continues to occupy the property as a principle place of residence;
- Term - equal monthly payments for a fixed period of months selected by borrower;
- as a “Line of Credit”;
- or any combination thereof:
- Modified Tenure - combination of line of credit and monthly payments as long as the borrower continues to occupy the property as a principle place of residence;
- Modified Term - combination of line of credit and equal monthly payments for a fixed period of months selected by borrower.
Reverse mortgages differ from other home loans in other respects. The borrower:
- does not need an income to qualify for such a loan;
- does not have to make any monthly payments;
- must be 62 years of age or older;
- must own the property in question and occupy it as his/her principle place of residence;
- must have paid off any mortgage or have only a relatively small balance remaining, with no other debt encumbering the property (with the exception of some state and local government loans);
- participate in a consumer information counseling session given by an approved Home Equity Conversion Mortgage (HECM) counselor.
The dwelling must:
- be a single family home (no limit on value of the home) or up to a four unit home in which the borrower lives in at least one of the units;
- or Dept. of Housing and Urban Development (HUD)-approved condominiums;
- or manufactured homes and leased land;
- And meet FHA property standards and flood requirements.
A reverse mortgage does not have to be repaid until the borrower moves, sells, or dies. Lenders recover their principle and interest once the home is sold. Whatever proceeds remain after sale goes to the homeowner or their survivors. A homeowner can never owe more than the fair market value of their home. If the profit from the sale is insufficient to pay the amount owed, HUD will pay the lender any shortfall. HUD’s Federal Housing Administration (FHA) collects an insurance premium from all borrowers to provide this sort of coverage. It should be noted that a borrower cannot be forced to sell the home to pay off the mortgage, even if the mortgage balance grows to exceed the value of the property.
- the borrower’s age (the older the borrower, the greater is the amount allowed to be borrowed),
- the current interest rates,
- other loan fees,
- and the appraised value of the home for that area (lower of the appraisal amount or FHA mortgage limit for the area, which ranges from $200,000 in rural locations to $360,000 in urban settings).
Generally speaking - the older you are, the more valuable your home is, and the lower the interest rates are - the more can be borrowed. However, the more equity used now, the less is available in the future.
Virtually all lenders charge adjustable interest rates on HECM loans. The rate can increase or decrease over time, tied to the current one-year or monthly US Treasure rate, subject to a “cap” of 2 percentage points per year and 5 total points over the life of the loan; or a 10 percentage point “cap” over the life of the loan for a monthly adjustable interest rate.
More costly private loans backed and owned by private companies that develop them are known as “proprietary” reverse mortgages. Because these companies have the ownership rights to the loans, they decide which lenders may offer them. Whereas federally insured Home Equity Conversion Mortgage (HECM) loans are backed by the federal government and may be offered by any lender approved by the FHA. If your home is worth more than HUD’s limit for your county, a proprietary reverse mortgage might give larger cash advances than an HECM. It also may cost less than an HECM in the earlier years of the loan.
The most expensive proprietary reverse mortgages will charge “contingent interest” in the form of “shared equity” or “shared appreciation” fees. The borrower will owe a percentage of the home’s value:
- when the loan is repaid - “shared equity”;
- since the loan was taken out - “shared appreciation”.
There are also reverse mortgages available for low income seniors that are low cost public sector loans offered by state and local governments:
- Deferred Payment Loans (DPLs) - commonly known as “redevelopment funds” or “community development block grants”, giving a one-time lump sum advance for repairing or improving the home;
- Property Tax Deferral (PTD) - provides annual loan advances to be used to pay property taxes.
Let’s take a simple example, to make things clear to the uninitiated, because reverse mortgages are often not well understood and complicated. Suppose Mr. & Mrs. Q, both 65 years of age, own their own three bedroom home in Davis. Purchased 20 years ago at $150,000, with $50,000 as a down payment, it was encumbered with a $100,000 mortgage. $40,000 is still owing on the mortgage. The present market value of the residence is $600,000 (a pretty typical example in Davis, where appreciation of houses has been quite high). To determine the amount of equity in the house that can be tapped into for a reverse mortgage, the following calculations are made:
Mr. & Mrs. Q have a number of options. They can establish a line of credit to borrow against from time to time; request a $40,000 lump sum to pay off their mortgage; take monthly payments over a selected period of years; accept monthly payments over their lifetime so long as they continue to live in the house as their principle place of residence; or some combination of the aforesaid. Sounds as if Mr. & Mrs. Q are sitting on a gold mine, with the world as their oyster, right? As it turns out, like everything else in life, there are advantages and disadvantages to reverse mortgages. Some pros and cons are obvious, others much more subtle.
THINGS TO THINK ABOUT BEFORE OBTAINING A REVERSE MORTGAGE:
- Because Mr. & Mrs. Q are only 65 years of age, they will not necessarily be able to tap into the entire $560,000 in home equity. HUD documents give the following example: “…based on an interest rate of approximately 9%, and a home qualifying for $100,000, a 65-year-old could borrow up to 22% of the home’s value; a 75-year-old could borrow up to 41% of the home’s value; and an 85-year-old could borrow up to 58% of the home’s value.” It appears that currently, a 65 year old can borrow roughly up to 25% of the home’s value.
- Another wrinkle are fees charged for application information. There have been difficulties with some senior citizens being charged thousands of dollars for information on reverse mortgages/home equity conversion loans for material that is available for free. Thus HUD recently directed reverse mortgage lenders to stop doing business with companies that charge such fees. Homeowners who were charged for HUD approved reverse mortgage counseling should call HUD’s toll-free housing counseling line at 1-800-569-4287.
- Reverse mortgage programs generally do not lend on cooperative apartments or mobile homes. Some manufactured homes may qualify, but only if they are built on a permanent foundation, classed and taxed as real estate, and meet other requirements. (Rancho Yolo Senior Mobilehome Park folks in Davis, who are trying to become a cooperative, should take heed of this potential pitfall and investigate!)
- The debt on your property grows ever larger as cash advances keep coming in and no repayment is made. Interest is then continually added to what is owed. Hence the reason reverse mortgages/home equity conversion loans are called “rising debt, falling equity” loans. As the amount owed increases, the equity in your home (fair market value less any debt against the home) generally decreases. This is the opposite of a “forward” mortgage, in which regular monthly payments are paid toward the debt to make it go down. Thus “forward” mortgages are called “falling debt, rising equity” loans. In a “forward” mortgage, debt is used to turn income into equity; whereas in a “reverse” mortgage, debt is used to turn equity into income. In both cases, debt is used to turn what the borrower has into what the borrower wants!
- A reverse mortgage may become due if:
- there is a failure to pay property taxes, homeowners insurance, homeowner association fees;
- declaration of bankruptcy;
- the home is not kept up but allowed to go to waste;
- abandonment of the home;
- perpetration of fraud/misrepresentation;
- eminent domain or condemnation proceedings;
- renting all or part of the home;
- adding a new owner to the title;
- a change in zoning;
- taking out any new debt on the home.
A lender may step in and make cash advances to cover such expenses.
- When the last surviving borrower dies, sells the home, or fails to live in it for the previous 12 months, then the reverse mortgage becomes due and owing. The total amount owed (loan balance) will equal:
- all cash advances received, including any made to pay loan fees/costs;
- all interest on cash advances;
- up to the loan’s “nonrecourse” limit (lender does not have recourse to anything other than the home).
If the borrower sells the home, the loan is paid back from the proceeds of the sale, or from other funds if the borrower has them and elects to do so. If the loan becomes due upon the death of the borrower, the loan can be repaid from the sale of the home or from other assets in the estate or by obtaining a forward mortgage on the home. Thus the borrower in a reverse mortgage situation must fully understand that such a loan leaves less money to prospective heirs. Furthermore, if the borrower faces medical problems that require a permanent move to an assisted living facility or nursing home, the loan will also become due.
- Out of pocket costs for a reverse mortgage can be extensive and staggering:
- interest charges;
- origination fees;
- closing costs such as title search & insurance, surveys, inspections, recording fees, mortgage taxes;
- monthly servicing fees,
- “equity-sharing” fees,
- “shared appreciation fees”,
- “maturity” fees
Of course these costs can be “financed” as part of the loan. It is essentially impossible to compare the true cost of reverse mortgages unless their Total Annual Loan Cost (TALC) rates are considered. Federal Truth-in-Lending law requires mortgage lenders to disclose the projected annual average cost of these loans that includes all costs and benefits, taking into account nonrecourse limits. The TALC shows what is being paid in total for the money a borrower gets to spend.
- TALC rates depend on two major factors: time and appreciation.
- TALC rates are generally greatest at first and decrease over time, because -
- Initial fees/costs become a smaller part of the total amount owed;
- The likelihood increases that the rising loan balance will catch up to and be limited by the nonrecourse limit.
- TALC rates depend on changes in a home’s value over time.
- The less appreciation, the greater the likelihood will be that a rising loan balance will catch up to and be limited by the home’s value.
- If the home appreciates at a robust rate, the loan balance may never catch up to and be limited by the home’s value.
Thus if a senior resides in their home past his/her life expectancy or the home appreciates at a low rate, then the borrower might get a real bargain in the reverse mortgage. But if the borrower dies, sells, or moves within just a few years or the home appreciates a great deal, the true cost of a reverse mortgage could be extremely high. For an explanation of TALC, on the internet go to www.reverse.org/talctuto.htm/.
There are some serious TALC shortcomings:
- TALC rates are generally greatest at first and decrease over time, because -
- TALC regulations assume all borrowers will request half their creditline at closing and none thereafter. Therefore it does not reveal how different true costs of loans can be based on a borrower’s pattern of creditline advances, nor does it reflect the value of a growing versus flat creditline.
- TALC regulations assume the initial interest rate on a loan will never change, when interest rates are almost always adjustable.
- TALC disclosures do not take into account:
- The total amount of cash received from the loan;
- The amount of equity the borrower/heirs are able to keep at the end of the loan.
- Any cash advances received from a reverse mortgage and kept past the end of a month are considered as a “ liquid asset”. If total liquid assets at the end of the month are greater than $2,000 for a single person receiving Supplemental Security Income (SSI - a needs based disability program run by the federal government) or $3,000 for a couple, the borrower could become ineligible for further SSI payments. Any annuity advances reduce SSI benefits dollar-for-dollar, and can also make the recipient ineligible for Medicaid. The borrower on a reverse mortgage should limit loan proceeds to what he/she expects to spend in one month’s time.
- Investing money obtained from a reverse mortgage is unwise. It is highly unlikely that the borrower can earn more from an investment than the loan would cost.
- Purchasing annuities using a lump sum cash advance from a reverse mortgage can be dangerous.
- Many annuities do not provide fixed monthly cash advances. The financial return of “variable annuities” may be tied to the stock market.
- There may be extra costs involved such as increased interest charges, a sales commission, or a surrender charge to stop an annuity.
- With an annuity, the borrower is locked into fixed monthly advances for life, but with reverse mortgage advances, switches to lump sum or creditline can be had at any time.
- Annuity advances are counted as income by SSI and Medicaid, and reduce cash benefits dollar-for-dollar, and might make the borrower ineligible for these public benefits.
- Annuity advances may be partially taxable. Interest charged is not deductible until the loan is actually paid. Loan advances are not considered income.
- In consequence, the borrower must wrestle with the following questions:
- Is a reverse mortgage appropriate for the borrower’s particular situation? What are other options? A deferred payment loan; tax deferral loan? Sell and move into a smaller home; rent; move into a senior facility appropriate to current needs, e.g. assisted living facility, nursing home? Or can the borrower remain in the home by tapping into public benefits, such as: Meals on Wheels; SSI; MediCal; utility discounts; in-home supportive care; transportation; tax reduction programs?
- If a reverse mortgage is deemed appropriate, when should it be taken out? Now, or at a more advanced age or when the home is worth more, making the amount available to the borrower greater? If the borrower waits, will the interest rates increase, making the amount available to the borrower less?
- And what amount should the reverse mortgage be for? Should it be for a credit line, monthly, or a combination of those? If a line of credit, how much should be used now as opposed to later? Should it be a growing or flat credit line? If a monthly advance, should it be for a term of years or as long as the borrower lives in the home, or would a purchased annuity providing lifetime advances no matter where the borrower lives be best?
Lesson to be learned: Reverse mortgages have various drawbacks and are quite complex for a variety of reasons. There are countless predatory scam artists and unscrupulous mortgage lenders ready to pounce on the unsuspecting. Many counselors are employed by the mortgage lender themselves, which creates a built-in conflict of interest. It should give any senior pause - before they decide to encumber the one valuable asset most older adults have - their home.
Further advice: Be careful about -
- Anyone eager for you to get a reverse mortgage, including family members, friends, caregivers or salesmen;
- Anyone who has ideas of what to do with the money once it is received from a reverse mortgage;
- Anyone trying to sell a reverse mortgage;
- Anyone trying to get a signature agreement to pay them for any purpose.
Try to choose a lender that is a member of the National Reverse Mortgage Lenders Association (NRMLA), an organization that has developed “best practices” for their industry. (For a complete list of lenders, go to: www.hud.gov/ll/code/llplcrit.html/.) Seek a second opinion from heirs, or a trusted friend or professional, depending on your particular situation. There is a three day recission rule allowing cancellation of a reverse mortgage if the borrower has second thoughts.
- All reverse mortgages turn home equity into three things:
- Loan advances to borrower;
- Loan costs paid to lender/others;
- Leftover equity paid to borrowers/heirs at the end of the loan.
- Analyze any reverse mortgage by asking three simple questions:
- How much would the borrower receive?
- How much would the borrower pay?
- How much would be left at the end of the loan?
- Actual figures will depend on three things:
- Actual credit advances taken during the life of the loan;
- Actual interest rates charged on the loan;
- Actual changes in the home’s value during the loan.
***Elaine Roberts Musser is an attorney who concentrates her efforts on elder law and aging issues, especially in regard to consumer affairs. If you have a comment or particular question or topic you would like to see addressed in this column, please make your observations at the end of this article in the comment section.