Since the credit and housing meltdown largely removed private reverse mortgages from the market, home equity conversion mortgages (HECMs)—federally insured reverse mortgages—have been growing steadily. Now, with housing activity improving in most markets, the time is right for homeowners age 62 and older to see if a HECM might work for them. The loans have been controversial, and they are complicated, which is one reason that consumer counseling is a required component of the HECM loan process.
Pros . The benefits of a HECM loan are that people get to stay in their homes as long as they wish without making further mortgage payments. They can access the available equity in their home whenever they want, and that amount of money is guaranteed to them because their loan is federally insured. They retain the title to the home until they leave, and any untapped equity or price appreciation can be captured by them or their heirs by selling the home. If they've stayed in the home so long that they owe more money on the HECM loan than the home is worth, they can simply walk away with no financial obligations under HECM's nonrecourse loan rules.
Cons. The downside of a HECM is that fees and closing costs can be steep. Also, a fair-sized percentage of a home's equity must be set aside to cover future interest payments on the loan funds that lenders have committed to pay to the borrowers. Some private firms selling HECMs have been charged with misleading and overly aggressive sales tactics. And some borrowers have been encouraged to use the loan proceeds to make risky or unwise investments.
[Also see The New Rules of Reverse Mortgages.]
Safeguards. Last week, the comptroller of the currency, John C. Dugan, compared reverse mortgages to subprime loans. Because borrowers need not provide financial information or credit scores to qualify for a HECM, he noted, it's not clear whether they have the financial ability to maintain the home and stay current on insurance and property taxes. Failure to do so is grounds for the lender to take over the home, and Dugan urged regulators to develop stronger consumer safeguards to weed out unqualified borrowers. An official with the Federal Housing Administration, which oversees the HECM program, says such defaults are less than 1 percent of HECM loans but that regulations will be proposed later this year to require lenders to seek financial information from loan applicants and to include set-asides for home insurance and taxes if they feel the borrower will have trouble keeping up with such payments.
Here are eight questions you should answer to determine if a HECM is a good idea for you.
1. Will you need to access the equity in your home now or in the near future? In planning your future housing and income needs, this is where to start. If you don't have a plan, it's probably wise to avoid a HECM or any other big-ticket financial decision. Under President Obama's stimulus program, the upper limit of an insured HECM loan was raised to $625,000 until the end of this year, at which time it falls back to $417,000. So if you have a home in that upper range, there is time pressure to consider a HECM. Jeff Lewis, chairman of HECM lender Generation Mortgage, says HECM terms are very favorable to borrowers and are unlikely to get any better, particularly with interest rates trending higher.
2. Is selling your home an attractive option? Current market conditions may make it hard to sell your home for what you feel it's worth. But if you can sell your home, you would net a lot more money than through a HECM. If you need the money and are not concerned about affording a new place to live, then a HECM doesn't make sense.
3. Can you qualify for a traditional mortgage to access equity in your home? If you own your home or most of it, is your income and credit profile suitable to take out a new loan on the home? Many older homeowners have insufficient income to qualify for a new loan on their homes, and taking on new debt usually is not a good idea for older consumers.
4. If you have a mortgage, can you afford to keep paying it when you retire? Some homeowners may have enough equity to qualify for a HECM, and their goal is not so much to pull money out of their home as to stop making mortgage payments and reduce their retirement budgets.
5. What should you expect to get out of a HECM loan? The most widely used loan calculator will allow you to determine how much money you'd get from a HECM loan. The key variables are the size of any outstanding mortgage on the home, prevailing interest rates, and your age—older borrowers get better terms because lenders assume they will remain in their homes for shorter times than younger borrowers. A very rough guide, the FHA official says, is that borrowers will get access to a percentage of the home's value equal to their age. A key thing to remember is that this money is effectively a guaranteed line of credit that can grow every year if it is unused. If you don't draw down the funds, your lender doesn't have to borrow any money to pay them to you, and that forgone interest expense is returned to you. In a simple example, if your HECM loan rate were 5 percent, your $200,000 unused line of credit would be $210,000 after one year, $220,500 after two years, and so on.
6. How long will you be able to stay in your home? HECM fees can be steep. The lender's fee is capped at $6,000, and borrowers must make upfront payments for the federal insurance premium and other closing costs. They also would have to put money away to pay for monthly loan servicing fees charged by the lender, but any unused portion of that set-aside is returned to the borrower when the home is vacated. Total fees easily can top $20,000, so a HECM does not make sense unless people expect to stay in their home for at least several years. A 75-year-old borrower, for example, would be able to access about $271,500 on a home valued at $417,000 and would pay $24,500 in loan-related charges. The include: origination fee ($6.000), FHA insurance ($8.340), servicing set-aside ($4,563), and other closing costs ($5,659).
7. Does your home qualify for the HECM program? The FHA says you must be at least 62 years old, continue to live in the home, and either own it outright or have a mortgage that can be paid off at closing with available HECM proceeds. Single-family and one-to-four-unit homes qualify (you must live in one of the units), the FHA says, along with condominiums and manufactured homes that meet applicable federal standards.
8. Do you already have a reverse mortgage and don't know it? Lewis says he regularly makes presentations and asks audience members if they have a reverse mortgage. Few hands are raised. Then he asks them whether their children and other family members regularly provide substantial amounts of money for household expenses. Many hands go up. "There's a tendency for reverse mortgages to be done informally in families," he says. "Children provide money regularly to their parents and expect to be paid back when their parents die or sell the house. As an alternative to this, people should explore a HECM."