Reverse Mortgages

Home Equity Conversion Mortgages (HECMs) are reverse mortgages insured by the federal government.  While these can be invaluable when an elderly person needs money, they can also be dangerous if the borrower does not fully understand all of the federal regulations administered by the Department of Housing and Urban Development.  Some statistics claim that between 8% and 10% are in default.  Therefore, applicants for an FHA/HUD reverse mortgage must take an approved counseling course to make sure they understand all of the advantages and disadvantages of a reverse mortgage.

The money received from a reverse mortgage is considered a loan advance since no monthly payments are made.  Since the mortgage is an advance, and not considered income, it does not affect Social Security benefits or Medicare benefits.   However, it could impact Medicaid or SSI benefits if the proceeds are put into a liquid fund (checking or savings account) beyond the end of the calendar month in which the money is received, and the amount of the assets is greater than what’s allowed for the SS or Medicare benefits.

Reverse mortgage loans come due when the borrower dies, sells the house, moves out of the house for more than 12 consecutive months, or the borrower fails to pay the property taxes or required property insurance. With an insured reverse mortgage, the borrower can never owe more than the value of the property and cannot pass on any debt from the reverse mortgage to any heirs.  The lender can only claim the property as collateral, not any other assets in the estate, and has no recourse against the borrower personally nor the borrower’s heirs.  In most cases, with an FHA-insured HECM reverse mortgage, the lender’s insurer (the federal government) covers the loss.

So, if the amount of the loan ends up being more than the fair market value of the home, surviving family members can opt to settle the reverse mortgage for a percentage of the full amount due, or 95% of the home’s current fair market value, which could be less than the amount due on the loan; the insurance pays the difference.   For example, if a loan balance is $308,000 yet the current fair market value of the home is only $250,000, the lender must accept $237,500 (95% of $250,000) to settle the loan, vs. the $308,000 that was borrowed.

Reverse mortgages are not without criticism.  Interest rates can be higher than on a traditional mortgage, and there are often high up-front costs, depending on the type.

Loan amounts can range from 62% to 77%.  Interest accrues not only on the principal amount received by the borrower, but also on the interest previously assessed to the loan.  The interest that accrues is treated as a loan advance.  If a senior has a reverse mortgage for a long period of time, chances are the entire amount of the equity in the home will be used up by the time the loan becomes due.  With no equity left, borrowers often end up short on cash in the future if money is needed (from the ultimate sale of the home) to pay property taxes, homeowner’s insurance, make home improvements, pay for health costs, or if money is needed to move to an assisted-living facility. If the owner fails to pay insurance and property taxes, the reverse mortgage is deemed in default and the bank can foreclose on the house.  Younger borrowers need to be sure they’re not using reverse mortgages to solve “short term” cash flow problems.

If the borrower still has a mortgage (often the case with younger reverse mortgage borrowers), the borrower still must pay off the existing mortgage.  And although the proceeds from the reverse mortgage can be used to pay off the existing mortgage, the borrower is not reducing the mortgage debt – just deferring it.

Borrowers should carefully review the differences between a fixed rate and adjustable rate reverse mortgage.  Fixed rates may be fine for a standard mortgage, but with a reverse mortgage, the interest accrues on the total amount borrowed and slowly reduces the total equity of the home.  An adjustable rate reverse mortgage may be better since interest is only accruing on what you use each month.

Make sure that you consider all of your alternatives before you borrow money.