Reverse mortgages have been around since the 1980s, but this once sleepy corner of the mortgage market really picked up during the Great Recession of 2008-2009, as thousands of cash-strapped seniors turned to what many financial advisors have long regarded as a loan of last resort.
Reverse-mortgage volume peaked in 2009 at about 114,000 loans and later returned to more typical levels. With another spike in demand potentially around the corner, federal regulators have been rolling out new rules designed to protect older borrowers and shore up the government-backed loan program.
The new rules – along with some changes in the way advisors view reverse mortgages – have helped to lessen the stigma around this much maligned slice of the mortgage market, which has come to be associated with TV ads featuring actor Henry “The Fonz” Winkler and other celebrity pitchmen.
Demand for reverse mortgages is expected to surge as greater numbers of baby boomers retire, many with not much saved. Through 2030, boomers are expected to retire at a rate of about 10,000 per day, according to a report by the Insured Retirement Institute. Some 59 percent of boomers expect Social Security to be a major source of their income during retirement, according to the report.
It’s not surprising, then, that reverse mortgages may become more popular again. Right now the reverse-mortgage market is a mere 1 percent of the size of the traditional mortgage market.
A reverse mortgage is a special type of home loan that allows borrowers who are at least 62 years old (and meet other eligibility requirements) to convert a portion of the equity in their homes into cash.
Loan proceeds can be taken as a lump-sum or monthly payment or as a line of credit. Interest is added to the loan each month, and the balance grows over time. A reverse mortgage must be repaid when the last borrower, co-borrower or “eligible spouse” sells the home, moves out or dies.
Most reverse mortgages are federally insured through the Federal Housing Authority’s Home Equity Conversion Mortgage program (HECM). The FHA – part of the U.S. Department of Housing and Urban Development (HUD) – reimburses lenders for losses tied to homes that sell for less than what is owed on the loans.
“We’ve tried to correct for some of the things we have noticed as the HECM program got more popular” during the last economic downturn, said Brian Sullivan, a HUD spokesman.
“This program was created to give seniors access to an incremental, sustainable financial resource to allow them to age in place, not as an ATM machine.”
-Brian Sullivan, spokesman for U.S. Department of Housing and Urban Development
“Retirement accounts got hammered,” Sullivan explained, “and TV commercials were telling people what a great thing these were.”
Under HUD’s new rules, borrowers can draw up to 60 percent of their initial principal limit in the first year of a loan, with some exceptions. In the past, some borrowers took out as much as they could up front and later found themselves with no capacity to cover critical expenses, including property taxes and homeowner’s insurance.
Borrowers who don’t pay their insurance and taxes on – or don’t make necessary repairs to – their properties are considered in default on their loans and may face foreclosure.
Some borrowers “were taking out the maximum amount of equity they could in these big, lump-sum draws initially,” explained Sullivan. “That exhausted all the equity available to senior borrowers and sometimes left them with little capacity to pay property taxes and insurance, which are an absolute condition” of reverse mortgages, he added.
“This program was created to give seniors access to an incremental, sustainable financial resource to allow them to age in place, not as an ATM machine,” Sullivan said.
Under the new HUD rules, lenders are also required to do a financial assessment of borrowers to determine whether they have the means to sustain themselves in their homes. If potential borrowers fall short, they may still qualify for reverse mortgages, but they will have limited access to the equity in their homes, because a certain portion of it must be “set aside” to pay for taxes, insurance and other property-related charges, such as homeowners’ association dues.
HUD has also implemented stronger protections for non-borrowing spouses. In the past, some seniors who weren’t eligible to be listed as borrowers because of their age, for instance, were forced to sell their homes or face foreclosure after borrowing spouses died or moved out (say, to assisted-living facilities) and loans became “due and payable.” Needless to say, consumer watchdog groups and advocates for seniors weren’t pleased.
Some brokers actually encouraged married couples to list one person on a loan in order to qualify for more proceeds under the formula that determines the maximum principal amount.
“Some of these borrowers didn’t understand that structuring the mortgage in this way put the non-borrowing spouse at extreme risk of being put out of the home at the death of the borrower,” said Sullivan, adding that, whenever possible, both spouses should be listed as borrowers.
Today a non-borrowing spouse can remain in his or her home, provided that person meets certain eligibility criteria and the lender and loan servicer agree to this. In order to be eligible, a non-borrowing spouse must have been married to the borrower at the time a loan was originated and has to be current on property taxes and insurance.
HUD – which requires prospective borrowers as well as any non-borrowing spouses to take part in a counseling session with a HUD-approved counselor – is expected to unveil more improvements to its HECM program in the coming weeks.
Jury’s still out – among advisors
But financial advisors remain divided in their opinions about reverse mortgages. Some continue to view them as costly loans of last resort and say potential borrowers should explore alternatives, such as a home equity line of credit or state and local programs for seniors. But some advisors have changed their tune on reverse mortgages.
According to the Consumer Financial Protection Bureau, reverse mortgages are usually more expensive than other types of home loans. Some experts say the loans, whose fees include initial and annual mortgage-insurance premiums, are comparable in cost to traditional mortgages with private mortgage insurance. Many borrowers finance the fees by paying them out of loan proceeds.
“I think reverse mortgages are appropriate for certain clients with limited other alternatives. However, I think the industry still requires a lot of cleaning up,” said Mark LaSpisa, a certified financial planner and president of Vermillion Financial Advisors, a fee-only firm.
For a couple of his clients, reverse mortgages have made a lot of sense, explained LaSpisa.
He recalls one elderly couple who took out a reverse mortgage in 2007 after depleting their savings and trying to scrape by on Social Security.
Their home was worth quite a bit, he recalls, but they still had a mortgage on it and its value was plummeting as a result of the housing bust. Their situation made it difficult, if not impossible, for them to refinance their home and take cash out or to take out a home equity line of credit, said LaSpisa.
The couple had four adult children who were financially independent and not concerned about whether they stood to inherit anything from the sale of their parents’ home. (If there is anything left over after a reverse mortgage is paid off, that money goes to the borrower’s estate.)
Proceeds from the reverse mortgage, said LaSpisa, helped to pay for nursing-home care for the wife, who had Alzheimer’s, and for a visiting nurse for the husband, making it possible for him to stay in the home.
“I don’t have a problem with the product as long as it is being applied to the right person and circumstances,” said LaSpisa.
Randall Bruns, a certified financial planner, says he has “come full circle” on reverse mortgages.
“In the past, we planners thought of reverse mortgages as a last resort,” said Bruns, a private wealth advisor at HighPoint Planning Partners. He is compensated mostly on an hourly basis.
New research, he noted, has shown that establishing a reverse-mortgage line of credit early in retirement may mean the difference between success and failure when it comes to sticking to a financial plan.
A reverse-mortgage line of credit, Bruns said, can give a retiree access to cash that can be used to ride out market corrections. Retirees can pay back what they draw from a line of credit when markets recover, he added.
“We know that retirement plans are won and lost during the most violent market crashes,” usually because retirees are forced to sell depreciated assets to raise cash, said Bruns.
“Broad markets have always recovered, but that only matters if you still own the original shares,” he said.
– By Anna Robaton, special to CNBC.com