Steve Sass, program director at the Center for Retirement Research at Boston College, tells PLANADVISER that a reverse mortgage “could be right if you plan to stay in the house your entire life. It’s not great if you are going to move. Of course, you don’t know if you’re going to move, so there’s risk, but there’s risk in everything.”
An individual must be at least 62 years old to receive a home equity conversion mortgage (HECM) loan, Sass explains, and essentially all reverse mortgages today are structured as HECM loans. Because the money received from the HECM is received as a loan, it is tax-free. The money borrowed, plus interest, reduces the home equity owned by the participant over time, and he or she can stay in the house without making any loan payments. In a case where the participant does move, sells the house, or dies, only what was borrowed by that point in time needs to be repaid. The participant will never owe more than what the house is worth, according to Sass.
There are different ways to use a reverse mortgage, Sass says:
- A line of credit, which can be used to pay for rising or unexpected expenses, or used as a source of income;
- A lump sum, which can be used to pay off a mortgage or to modify a home;
- Fixed payments either for life or for a set period of time. These payments can be used as income that cannot be outlived; however the payments do not increase with inflation. They can also be useful when delaying Social Security claims to increase monthly Social Security benefits.
With both perks and caveats, are reverse mortgages a good idea for generating income in retirement? “A reverse mortgage makes sense for someone looking to leverage home equity for income in retirement,” Sass explains. “Your home is typically your largest expense and asset,” he adds. “So if you need more income, a reverse mortgage is the place to look.” He notes that individuals cannot simply initiate a reverse mortgage without approval. They must pass a required credit check, which analyzes whether or not they are able to make payments for taxes and insurance going forward. If they do not pass the test, they will not get a loan.
Joe Connell, president of Retirement Plan Partners in Maple Grove, Minnesota, and the 2014 PLANSPONSOR Retirement Plan Adviser of the Year, considers that a reverse mortgage can be ideal for a “married couple who is not worrying about their estate, is in need of additional income, has lived in their home and doesn’t want to vacate, and doesn’t have serious health issues.” Provided that the loan is done under the right circumstances and the participants stay healthy and stay in the home for a long time, Connell believes a reverse mortgage has the potential to give them enhanced quality of life in retirement.
Sass and Connell both note that an individual is required to meet with a government-approved counselor in order to get a reverse mortgage loan. “You need to understand the benefits and alternatives of the loan, as well as how to avoid scammers,” Sass says. He adds that a lot of problems stem from the fact that “all of a sudden you have a lot of cash and there are scammers that want to sell to you. Not all retirees are as careful and as savvy as they should be.”
A key factor in deciding whether or not take a reverse mortgage is determining how much the individual can get. The more valuable the house, the lower the interest rate, and the older the individual, the more he or she can get from a reverse mortgage. The stipulation is that no more than 60% of the gross amount of the loan can be borrowed in the first year, unless it is used to pay off a mortgage or make required repairs. In that case, the mortgage insurance fee at closing rises 2% (from 0.5% to 2.5%), Sass says.
Fees are another key element. “Costs are quite high for reverse mortgages,” says Connell. He lists fees, interest rates, and the current economic environment as obstacles when taking a reverse mortgage. “Lenders are reluctant to give home equity loans to seniors,” he adds.
Fees for reverse mortgages may include ordinary mortgage fees, including for example, legal fees; an origination fee to cover lender expenses; mortgage insurance to insure the participant gets all promised payments and the bank is repaid even if the value of the house, when sold, is less than what is owed; and a service fee to cover projected servicing costs, which is often waved. A retirement planning guide published by the Center for Retirement Research at Boston College provides an example. While fees vary by lender, reasonable estimates on a house worth $250,000 are: $2,500 for ordinary fees; $4,000 for an origination fee; and $1,250 for mortgage insurance. This totals $8,250 in fees, which is 3.3% of the house value.
A plan adviser’s understanding of reverse mortgages, and the initiative advisers take with employees or retirees who are interested in taking one, is crucial. Connell suggests that plan advisers attend the meeting between their client and the government-approved counselor in order to better understand the situation. He also suggests using the resources of an affiliate or specialist.
“When you get involved with real estate there are specialists out there to bring to your client relationship,” Connell says. “You can’t be an expert in every area. It would add value if you had that specialist with you.” In addition, Connell listed several resources for advisers and retirement plan sponsors to gain knowledge about reverse mortgages, including eldercare.gov (a public service of the U.S. Administration on Aging), www.ncoa.org (National Council on Aging), and aarp.org (American Association of Retired Persons). “It’s a timely topic and an option that sometimes people don’t consider,” suggests Connell. “Advisers should understand it and be able to assist their clients.”
The federal government’s FY 2013 HECM Actuarial Review reveals that there were 61,296 endorsements totaling $14.88 billion in 2013. HECM borrowers represent about 0.9% of all households with at least one member age 62 years or older (according to AARP). If this ratio is maintained, the number of reverse mortgages will continue to increase with the expected growth in the senior population.
Additional guidance about how to effectively deploy HECMs is available in a white paper from the Center for Retirement Research, penned by Sass, Alicia H. Munnell and Andrew Eschtruth.