Are Reverse Mortgages Only for Idiots?
There are certain everyday terms that never killed anyone but have become expletives in the wake of the financial collapse. Included are ARMs (adjustable rate mortgages), sub-prime, credit default swaps, and, probably to a lesser extent, reverse mortgages. "Reverse mortgage" sounds like an easy way for something bad to happen to your house. But despite the bad name, they can actually be a very wise financial decision - of course, depending on the circumstances of the borrower in question.
A reverse mortgage is an FHA-insured loan, officially called a Home Equity Conversion Mortgage (HECM). (And yes, it is pronounced, "heckem.") The basics are here, but as usual, I'm going to be a nice guy and tell you what you really need to know, right here.
When you buy a home with a typical mortgage (referred to in this context as a "forward" mortgage), you put down a certain amount of money - let's say 10% - and finance the rest over some time, usually 30 years. You have a monthly payment that includes principal, interest, mortgage insurance, property taxes, and homeowners insurance. You pay on that loan until it's paid off, or more likely until you refinance, sell the house, or die. After all, the term "mortgage" is a blend of the Latin roots "mort" (dead) and "gage" (pledge).
The first manner in which I will blow your mind is to tell you that you can actually BUY a house using a reverse mortgage. I admit, I did not know this myself until just recently. I thought reverse mortgages were for very old people who owned their house outright and wanted or needed to access the equity. And although that is still part of the picture, since I'm a real estate broker I am fixating on the ability to purchase a home using a reverse mortgage.
A reverse mortgage works the opposite way from a forward mortgage (but you knew that). Simply put, the borrower makes a down payment - larger than what most people are putting down these days on forward mortgages - closes on the house, and does not make any mortgage payments whatsoever for the remainder of the time they live in the house. The benefit here is pretty obvious - the borrower doesn't have to make a mortgage payment, ever. At this point many readers will think, "But the mortgage balance grows because they're not making payments!" It's true. The interest that normally would be paid monthly instead accrues and is capitalized (added to the principal balance of the loan). On a $200,000 loan, at 4.5% interest, that's $750/mo. Today's reverse mortgage interest rates are slightly higher (and also unrelated, tied to different indices, and much more stable) than forward mortgage rates, clocking in at 4.00-4.50%. So the fear is that the mortgage balance grows too much, too fast, creating a negative equity or "underwater" situation, right?
Time for an example to illustrate why that's less of a problem than you might think, which will result in a second blowing of your mind. Let's say Bertha is a 70-year old widow, living on a fixed income consisting only of social security. Bertha, like most human beings, likes to eat good food, spend time with the family, maybe go somewhere warm every now and then. And of course she has regular bills to pay, like insurance, prescriptions, cable, that good old land line, and her riverboat allowance. Well, with increasing cost of living, Bertha ain't doing so well anymore - the grandkids are getting $5 bills for their birthdays as opposed to the customary $10, and the penny slots are the only thing at the casino seeing any action.
(I'm still working on blowing your mind again, this point just takes awhile to develop. Hang in there.)
So let's say Bertha buys a house. Why, you ask? Well, Bertha had to get double knee replacement surgery, and her tri-level home won't cut it anymore, so she has to get a ranch. So anyways, let's say Bertha buys a house. Let's say Bertha buys a house for $300,000. Let's say Bertha buys a house for $300,000 and puts $100,000 down. So here's Bertha with a $200,000 mortgage to pay, on top of all the aforementioned expenditures. She's coughing up $900/mo for principal and interest (assuming 3.5% interest), not even counting property taxes or homeowners insurance. Not looking real good for Bertha, or the casino, or the birthday cards.
Alternatively, let's say Bertha buys a house for $300,000, puts $100,000 down, and gets a reverse mortgage. She still owes $200,000, but she has no mortgage payment. As she's told you a thousand times by now, she's 70 years old and she's earned it, so why shouldn't she be able to enjoy it? Her mortgage interest is capitalized at a rate of $750/mo (assuming 4.5% interest), and she lives out the autumn of her years, giving out full $10 birthday cards and playing only the newest of the new slot machines, until she fulfills her life expectancy of 81. At that time, her mortgage balance has grown by $126,500 (4.5% annual interest and 1.25% annual FHA mortgage insurance for 11 years). During the same 11-year period, with a traditional mortgage she would have made principal and interest payments totaling over $118,000. So in the end, it cost her a few thousand more. But the difference is the $118,000 Bertha did NOT spend on mortgage payments while she was still here, that was instead spent on enjoying what she's worked her whole life to enjoy.
And here's where I arrive at the mind-blow: By this point, the house might be worth $400,000. The family/estate inherits the house, sells it for $400,000, pays off the $326,500 mortgage, and keeps the proceeds. Just to be clear: If there is equity, nobody steals it. It belongs to the owner, and/or their estate. Sure, it may not be much, definitely not as much as if she'd have gotten a forward mortgage, but what would any decent son or daughter want - more money for themselves upon their mother's death, or more money for her during her life?
Final mind-blow: If this story happened to take place in a declining real estate market - I mean, purely hypothetically speaking, because we've never seen anything like that - and the home's value fell from $300,000 to $200,000 while the mortgage grows to $326,500... Assuming the family/estate doesn't want the house, the bank takes title to the property, appraises it and sells it, FHA chunks in the negative equity ($126,500) to cover the difference, and the family/estate is off the hook. That's the beauty: Reverse mortgages are non-recourse loans. They are secured ONLY against the subject real estate, without the ability to pursue any other income or assets, and they're insured by FHA to account for the risk that the principal balance accrues faster than the home's value.
It's definitely not a product for everyone, but in certain situations a reverse mortgage could be a real quality-of-life-saver. Some of the less interesting but nevertheless pertinent facts are:
- Only senior citizens (age 62 or older) can obtain a reverse mortgage. Most people who get one are 70 or older.
- Required down payment amounts vary with age - the younger you are, you more you have to put down - but will not be lower than 15% or higher than 50%.
- Just like with forward FHA loans, there is an upfront mortgage insurance premium charged at the closing in addition to the monthly/annual mortgage insurance premium. For reverse mortgages, the upfront MIP is 2% of the loan amount and can be financed into the loan.
- There are currently no credit or income requirements, although some will go into effect this fall. They will be much looser requirements than what is expected in order to obtain a forward mortgage, so seniors on fixed incomes who might have difficulty qualifying for a forward mortgage can still obtain a reverse mortgage much more easily.
- There are other reverse mortgage programs available, outside of the fixed "Standard/Saver" program I've outlined here, which involve lines of credit, benefits from an increasing interest rate environment, etc.
In the end, the benefit is that your family member or loved one may be able to live the last years of their life more happily, or use a reverse mortgage to buy into a supportive, adult community that may not otherwise be affordable for them. And for an elderly person with no children (or only worthless, irresponsible children to whom they would never leave their estate), a reverse mortgage is a no-brainer.
Back to that question about reverse mortgages and idiots, though... Nope. They can be a great decision and in many instances are recommended by financial advisors and estate planners. If it sounds like a consideration for anyone in your family, let me know and I can put you in touch with someone who specializes in these.
Janet, I'm not 100% sure, my guess is you can only have one reverse mortgage at a time. I will give you a call to put you in touch with a lender and agent who can help you in Shreveport and Austin!
Alex Fenske, almost 8 years ago
Thanks for reading. The situation you described does sound feasible. Do you know a lender in your area who does reverse mortgages or would you like for me to connect you with one I know who does loans nationwide?
Alex Fenske, almost 8 years ago
Thanks Alex, that would be great! I live in Shreveport,La and will be moving to Austin, Tx. It seems most people like myself have never heard of purchasing a home with a reverse mortgage. Is it possible to do this more than once eliminating the holding cost while rehabbing a house? I know that isn't the intention of RM but just thinking outside the box.
Thank you for informing all of us.
Janet Taylor, almost 8 years ago
Janet Taylor, almost 8 years ago
Janet Taylor, almost 8 years ago