SHIFTING INTO REVERSE
If your loved one needs cash now, is the best move to pay the mortgage later?
Henry Stone's mother-in-law, Celia Hayes, was struggling financially. Her small portfolio of investments had been decimated by her monthly bills, including the cost of healthcare, and she was living on Social Security. Henry and his wife discussed options with the 82-year-old widow—including selling her home and downsizing—but she wanted more than anything to stay in the home she loved. It was clear that she did not have enough income to take on the payments of a new conventional mortgage or home-equity loan, so Henry turned to a financial tool available to other homeowners in Celia's situation: a reverse mortgage.
"The bottom line was, if my mother-in-law wanted to stay in her home with her rose garden, she had no alternative," Henry says. And as long as she lived there, she wouldn't have to repay a cent.
Think of a reverse mortgage (RM) as the mirror image of a conventional mortgage. It's a loan against the equity in the home that comes due only when the homeowner dies or moves. After Celia Hayes passed away, her daughter and Henry sold the house and repaid principal plus interest.
"A reverse mortgage is a needs-based product," says John Nixon, Bank of America senior VP and operations executive. "Eighty percent of [RM] borrowers need this product to maintain and sustain their standard of living. It can significantly improve cash flow." This, he adds, can be important for "retiring baby boomers who don't have access to retirement plans of earlier generations or seniors with high medical costs who prefer to age in place."
The popularity of RMs is growing. AARP recently completed the first national survey of reverse mortgages, and reported that the market has more than doubled in the last two years, to over 100,000 borrowers in 2007. This may be due as much to aggressive TV advertising featuring septuagenarian actors James Garner and Robert Wagner as to the number of seniors who find themselves short of funds and living in their nest egg. "The home has become, in effect, a savings account for many people," says Jim Mahoney, chairman of Financial Freedom Senior Funding, the country's largest originator of RMs.
"The reverse mortgage can be a lifesaver," says Shelley Giordano, mid-Atlantic reverse mortgage manager of Wells Fargo Home Mortgage. Reasons for taking out such a loan vary from paying off an existing mortgage to providing for basic needs like heat, food or prescription drugs.
In 2005, the National Council on Aging released a report on their investigation of the merit of using RMs to fund long-term healthcare, but ultimately rejected that idea. "There was no real link between the two," says Barbara Stucki, a project manager for the "Use Your Home to Stay at Home" initiative. "Instead, we discovered that the focus should be on using reverse mortgages to encourage aging in place," she says. Funds can be used to make home modifications, pay for in-home healthcare and provide respite for family caregivers.
To qualify for an RM, you must be at least 62, own your home and live in it as your primary residence. Credit rating and income have no bearing on loan approval. Loan amounts depend on the age of the youngest borrower, the value of the home and its location. Because the IRS considers RMs to be loan advances rather than income, these monies are tax free and do not impact Social Security or Medicare. If you have an existing mortgage or a lien, you must be able to pay it off with funds from the reverse mortgage.
At www.aarp.org/money/revmort, AARP's reverse mortgage website, you can get a rough idea of what you might receive. For example, a 70-year-old with a $300,000 home on New York's Long Island may be eligible for about $185,000. But if the co-borrower is only 65, the available amount decreases to around $173,000.
This example brings up two important points. First, you won't get close to the full value of your home—only between 50 and 70 percent. And second, it's better to wait until you are older; if you take out a reverse mortgage too soon, there is a chance you'll outlive the money. If that happens, you won't be thrown out of your home, but you'll have to find another source of income to pay bills.
Not All RMs Are the Same
There are two basic types of reverse mortgages: the Home Equity Conversion Mortgage (HECM) and private loans offered by banks and other lenders. The HECMs are insured by the U.S. Department of Housing and Urban Development (HUD) and account for 90 percent of the market. However, the Federal Housing Authority has limits on a home's value based on location, and that affects the amount available through an RM. At press time, the limit is about $362,000 (a bill pending in Congress could raise that cap). So, for a property valued at more than that amount, you may want to investigate one of the private (or proprietary) loans offered by companies like Bank of America, Wells Fargo, Financial Freedom and others. Funds can be taken in a lump sum, as monthly payments, a line of credit, or as a combination of these plans [click here for pros and cons of each]. If you choose a monthly or line-of-credit distribution plan, the amount you owe increases each time you take money, and your equity in the home decreases.
"You can never owe more than the home is worth," notes BofA's Nixon. "The house is the sole collateral." If, for example, the balance on the reverse mortgage is $200,000, but because of real-estate market conditions the value of the house has decreased to $180,000, the federal government or the private lender, depending on your loan type, will cover the shortfall. "The lender cannot seek recourse by attaching any other assets," adds Nixon.
What Caregivers Need to Know
Reverse mortgages bring certain challenges for caregivers, including their making sure the homeowner for whom they care fully understands the process. To help with this, counseling is mandated for all federally insured HECMs. It is recommended, as well, for private loans.
Carla Hunt helped her 82-year-old mother get a reverse mortgage and had her own learning curve. "I kept asking the counselor questions over and over until I finally understood what a reverse mortgage involved," she says.
"It's not a simple process," adds Patricia Bell, who also helped her mother. "I have two filing cabinets full of papers."
Reverse mortgages come with a trade off—financial independence in the present versus an unencumbered home in the future. They also come with a price tag. Costs—which include an origination fee, mortgage insurance, a monthly service fee, appraisal, inspection, title insurance and other standard closing costs—are high. On that aforementioned $300,000 loan, for instance, fees and closing costs likely would be in excess of $15,000. That amount could be rolled into the loan and not be payable until the mortgage comes due. To get a handle on what RM costs might be, click here.
"You need to stay in your home at least five years to make it pay," says Stucki. For example, it rarely makes sense for a single person who may soon need nursing-home care or will be moving in with her adult children to get a reverse mortgage. Stucki says the question for caregivers is, "What do you do with the home and when do you do it?"
Here are some things to consider before making any decisions:
Research all options. Maybe it's not so important to stay at home. Maybe downsizing is the right choice based on health concerns or realistic assessment of the need for extra space.
Create a realistic budget. Know how much you need and for what you'll use the money. Maybe family members can help out with temporary financial needs.
Get the house ready. Make repairs to get the best appraisal value. Ask your real-estate broker what increases value most.
Consider the timing. Experts agree that unless the person in your care really needs money immediately, it might be better to wait. Given the growth in the RM market, new products continue to be introduced. And pending legislation may ease the process.
Maintain upkeep. All reverse-mortgage borrowers are responsible for taxes, maintenance and insurance. Failure to meet these obligations could result in foreclosure.
Bring all concerned parties on board. Family members should know what they're getting into and manage expectations. The loan has to be paid back, so a reverse mortgage does impact an estate. A reverse mortgage doesn't necessarily result in the heirs getting nothing, but there should be consideration of how a reverse mortgage affects inheritance expectations. Some homeowners use funds from the RM to give their kids an "early" inheritance. Other people with reverse mortgages have their heirs simply choose something special from the house.
While the principal plus interest must be paid off when the homeowner dies or moves out, the loan could be paid by switching to a conventional mortgage. If the house is sold, then any positive difference between the reverse-mortgage loan balance and the sale price goes to the heirs.
Reverse mortgages are not for everyone, cautions Shelley Giordano of Wells Fargo, but under the right circumstances they can bring peace of mind for both homeowner and caregiver. "A reverse mortgage, she says, "gives the ‘sandwich generation' some flexibility in caring for their parents, and helps the parents remain independent."