R is for a Review of Reverse Mortgages
Personal Finance from A to Z
Eileen St. Pierre, The Everyday Financial Planner
In 1989, I was a bank teller during my senior year in college. One day a very sad older man came into the bank. The other tellers knew him well. He came to take his wife’s name off all his accounts because he had to divorce her – he was doing this so that she could qualify for Medicaid to pay for her long-term care. I have never forgotten this man and have made it my mission to make sure older Americans know of their financial options. At the time I met this man, the reverse mortgage market was in its infancy. But if I met him today, I would explain to him how a reverse mortgage could be a last resort option for him, and allow him to remain married to his wife.
Reverse Mortgage Basics
A reverse mortgage allows a homeowner age 62 and older to convert part of his/her equity into cash while still living in the house. The lender makes payments to the homeowner. While interest is added on to the loan, the loan does not have to be repaid until the homeowner dies, sells the house, or moves out.
Big Changes Made to Reverse Mortgages
At the end of July 2013, Congress passed the Reverse Mortgage Stabilization Act of 2013. This legislation led to big changes in the reverse mortgage program administered by the U.S. Department of Housing and Urban Development (HUD). It consolidated all the different types of reverse mortgages into one product and focused on lowering the risk of default.
Less Upfront Money
Now the amount of money you can access through a reverse mortgage is reduced by roughly 15%. After analyzing the history of its reverse mortgage program, HUD determined the riskiness of these loans was directly related to the size of the upfront draw.
- You will only be able to withdraw 60% of your approved amount (called the initial principal limit) in the first year. The upfront fee will be 0.5% of the appraised value of the property.
- There is an exception. If homeowners have “mandatory obligations” such as an existing mortgage or delinquent federal debts like student loans, they can withdraw enough to pay off these obligations plus an additional 10%. Credit card debt is not considered a mandatory obligation. These borrowers will have to pay a higher upfront fee – 2.5% of appraised value.
- If you choose a fixed rate option, you will get your money in a lump sum but you will not be able to withdraw any more money after that. Borrowers that choose a variable rate option will be able to withdraw more money via a line of credit or fixed monthly payments after the first year.
- All reverse mortgage borrowers will still have to pay the annual mortgage insurance premium, which will remain at 1.25% of the outstanding loan balance.
Protections Added to Protect Against Default
One of the problems with reverse mortgages was that homeowners did not realize they still needed to pay property taxes and insurance on the home, leading them to default. This default rate is significant. The Consumer Financial Protection Bureau (CFPB) reported that 9.4% of active reverse mortgages were in default on taxes or insurance as of February 2012.
- Lenders are now required to check to see if homeowners can make these payments before approving the loan.
- Homeowners who do not have enough money left over after paying typical living expenses will be required to set money aside to make tax and insurance payments. This will reduce their proceeds from the reverse mortgage, and may lead to higher disqualification of lower-income homeowners.
In my opinion, these changes were necessary. According to the CFPB, homeowners had been taking out reverse mortgages, mostly as lump sums, much earlier in their retirement, leaving them with no financial options left for later in life. When used correctly, a reverse mortgage can be part of a long-term retirement plan. These changes make homeowners think more long-term about how they are going to use the years of equity build-up in their homes to benefit them in their golden, golden years.