Reverse mortgages

A reverse mortgage allows homeowners 62 and older to withdraw a portion of home equity as income or a line of credit without selling the home or making monthly payments. In 2009, half of homeowners 62 or older had 55% or more of their net worth in home equity. A reverse mortgage has been described as a loan of last resort because it can mean fewer assets for the homeowner and heirs. When the last surviving borrower dies, sells the home, or no longer lives in the home as a principal residence, the loan has to be repaid. In certain situations, a non-borrowing spouse may be able to remain in the home. The first reverse mortgage in the United States was issued in 1961. In 1987 Congress passed a reverse mortgage pilot program called the Home Equity Conversion Mortgage Demonstration, signed into law in 1988.

Reverse mortgages saw abuses by lenders and earned a bad reputation when the housing bubble burst in 2008-2010. The number of reverse mortgages dropped from an annual peak of about 115,000 in 2009 to 30,000 in 2016, according to the Federal Housing Administration. Reverse mortgages are now regulated by the Federal Housing Administration and the Consumer Financial Protection Bureau. For FHA Home Equity Conversion Mortgages, the FHA covers any difference between the sale value and the mortgage balance, preventing "underwater" loans.

There are three types or reverse mortgages: FHA Home Equity Conversion Mortgage (HECM), single-purpose reverse mortgage, and proprietary reverse mortgage.

FHA Home Equity Conversion Mortgage (HECM)
The Federal Housing Administration's (FHA's) Home Equity Conversion Mortgage (HECM) is a federally-insured mortgage backed by the U. S. Department of Housing and Urban Development (HUD). The loans can be used for any purpose. They are more expensive than traditional home loans or single-purpose reverse mortgages and the financing costs are higher, a factor if the home stay is short or the mortgage is small.

In general, the older you are and the more equity you have in your home, the greater the loan can be.

One unusual suggestion for a reverse mortgage is for buying a new home to downsize: "'Instead of eliminating debts, paying for healthcare or covering daily living expenses, you can also use a reverse mortgage to purchase a new home that better suits your needs. The advantage of using HECM for Purchase is that the new home is purchased outright, using funds from the sale of the old home, private savings, gift money and other sources of income, which are then combined with the reverse mortgage proceeds. This home buying process leaves you with no monthly mortgage payments.'"

FHA HECM Counselor training manual
A helpful reference to the details of the program is the counselor training manual "Introduction to Home Equity Conversion Mortgages (HECM)" by the NeighborWorks Training Institute.

FHA HECM Reverse mortgage calculator
The input and output forms for the National Reverse Mortgage Lenders Association (NRMLA) calculator are shown below (click on an image for full size). Sample cases were run in 2016 for
 * a $200,000 home
 * in the Midwest
 * with no mortgage, and
 * owners of the same age, for a range of ages.

In general, the "net loan limit" (maximum loan after fees) and amount available in the first year increased with age, while interest rates were constant. The calculator endnote and disclosure say that results vary with lender, geographic location, and prevailing interest rates. But if you want your entire home value, you'll have to sell.

Single-purpose reverse mortgage
Single-purpose reverse mortgages are the least expensive option. They’re offered by some state and local governments and non-profit organizations, but they’re not available everywhere. These loans may be used only for the purpose specified by the lender, for example, home repairs, improvements, or property taxes. Low or moderate income homeowners can qualify for these loans.

These loans are not widely available and make up a tiny percentage of the reverse mortgage market. They often go by another name, such as property tax deferral programs. These can be found online for California, Colorado, Connecticut, Idaho, Illinois (contact County Treasurer's office), Massachusetts, Michigan, Minnesota, Oregon, Tennessee, Texas, Washington, Wisconsin, and Wyoming. Approximately half the states have some type of property tax deferral program. Check your state.

Proprietary reverse mortgage
Proprietary reverse mortgages are private loans backed by the companies that offer them. Higher-appraised homes might qualify for a bigger loan with a proprietary reverse mortgage. They are more expensive than traditional home loans or single-purpose reverse mortgages and the financing costs are higher, important if you plan to stay in your home for a short time or borrow a small amount.

The loan size depends on the same factors as an HECM, but is limited only by the risk the lender is willing to take. These mortgages vanished after the housing bubble burst in 2008-2010, then returned when home prices rebounded. They aren’t as common as HECMs because they lack a secondary market for lenders, and cannot be easily secured by sale to Fannie Mae and Freddie Mac.

Reverse mortgage criticism
The most common criticism is that reverse mortgages are more expensive than traditional home loans and the financing costs are higher. But other problems have been noted:
 * Because there are no required mortgage payments, the interest is added to the loan balance each month. The rising loan balance can eventually grow to exceed the value of the home, particularly in times of declining home values or if the borrower continues to live in the home for many years. That said, with an FHA-insured HECM the borrower can never owe more than the value of the property.
 * Reverse mortgages can be confusing, and many obtain them without fully understanding the terms and conditions. In October of 2010, the National Reverse Mortgage Lenders Association (NRMLA) surveyed 600 owners with reverse mortgages across the U.S., and only 46% of respondents felt they understood the financial terms "very well" when they secured their reverse mortgage. A Consumer Financial Protection Bureau report to Congress in 2012 stated that "government investigations and consumer advocacy groups raised significant consumer protection concerns about the business practices of reverse mortgage lenders and other companies in the reverse mortgage industry." But a 2006 survey of borrowers by AARP showed 93 percent said their reverse mortgage had a "mostly positive" effect on their lives. And the 2010 NMRLA survey reported 56% of seniors with a reverse mortgage would not be able to cover monthly expenses without it.
 * Information available to help consumers understand prices and risks, including federally required disclosures and counseling, are not sufficient to ensure that they are making good decisions.
 * Homeowners are taking out reverse mortgages at increasingly younger ages with more money upfront, exhausting their resources sooner.

Other options
Unlike a reverse mortgage, the first two options require monthly repayments to the lender. A reverse mortgage is generally easier to qualify for than a home equity loan or home equity line of credit (HELOC), which require adequate income and credit scores. The HELOC is more flexible than the home equity loan, and a less expensive way to borrow smaller amounts if the principal is paid back quickly. In general, a reverse mortgage is better for long-term income in spite of a reduced estate. A home equity loan or HELOC is better for short-term cash, if you can make monthly repayments and want to avoid selling.

Home equity loan
A home equity loan is a "second mortgage", a lump sum paid back over a set time period, using the home as collateral. The loan is based on the difference between the homeowner's equity and the home's current market value. The mortgage also provides collateral for an asset-backed security issued by the lender and sometimes tax-deductible interest for the borrower.

Interest rates on such loans are usually adjustable rather than fixed, but lower than standard second mortgages or credit cards. Loan terms are usually shorter than first mortgages.

Home equity line of credit
A home equity line of credit (HELOC) is more like a credit card that uses the home as collateral. A maximum loan balance is established, and the homeowner may draw on it at discretion. Interest is predetermined and variable, and usually based on prevailing prime rates.

Once there is a balance owed, the homeowner can choose the repayment schedule as long as minimum interest payments are made monthly. The term of a HELOC can last anywhere from less than five to more than 20 years, at the end of which all balances must be paid in full. The interest is often tax-deductible, making it more attractive than some alternatives.

Government benefit programs
Many consumers considering a reverse mortgage may not realize they are eligible for government benefit programs. One reverse mortgage counseling agency reports finding other solutions for 50% of the potential borrowers it counsels. Available benefits include federal programs such as Supplemental Security Income (SSI) and state and local programs such as home energy assistance.

Taxes and Government Assistance
Reverse mortgages have been suggested as a possible tool to lower income taxes in retirement (See Social Security tax impact calculator). Generally, money from a reverse mortgage is not taxable and does not affect Social Security or Medicare benefits. Eligibility for certain government assistance programs may be limited.