In 1988, in an effort to keep older Americans in their homes, Congress passed the Reverse Mortgage bill, which authorized the Federal Housing Authority (FHA) and the United States Dept. of Housing and Urban Development to guarantee lenders who made home equity conversion mortgages. These specialized loans are limited to individuals 62 years or older for loans secured by their primary residence, and for a loan amount that provides a sufficient equity cushion so that at maturity the loan may be repaid. Reverse mortgages can be used on single family homes, condominiums and certain manufactured homes.
Reverse mortgages do not require any payment of principal and interest as long as the borrower is alive or resides in the home as the primary residence. Interest on the reverse mortgage (which can be fixed or adjustable) accrues until the loan is repaid. The homeowner/borrower must still pay all taxes, insurance and maintenance on the residence.
This waiver of payment is the main benefit of the program. For example, a homeowner with a $250,000 mortgage paying interest at 5.5% with fifteen years left will be paying $1,419.47 each month in principal and interest. With a balance of $167,000 after fifteen years, and a home value of $400,000, a homeowner over 62 could obtain a reverse mortgage of $191,200, pay off the earlier loan, pay all closing costs (which are generally higher than most loans and one source of complaints about reverse mortgages) and have about $20,000 available to pay taxes and insurance (or a vacation). After closing, the borrower will have the $1,419.47 in his or her pocket each month, an amount that may mean the difference between selling the home and keeping the home.
The funds from a reverse mortgage can be received in cash at closing, or available as a line of credit for future withdrawal. The availability of a line of credit at closing requires that the borrower have sufficient equity for the new loan (in many cases, paying off the existing loan plus closing costs reduces or eliminates the amount available to borrow). The proceeds from a reverse mortgage are not generally considered income and are not taxable, and will not affect social security or Medicaid benefits, but if the proceeds are held as liquid cash, that sum could disqualify a person from certain benefits and should be reviewed.
Loan repayment occurs when the homeowner dies, abandons the home or defaults under the terms and conditions of the loan (such as failure to pay taxes). For death or abandonment, the homeowner or his/her family gets twelve months to sell the property to pay back the loan. If the loan is not paid back, HUD may proceed to foreclose the loan, recover and sell the property to satisfy the debt. Since interest is accruing without repayment, the value of the property may not be sufficient to pay-off the loan. Unlike conventional mortgages (recourse loans), the borrower or the borrower’s estate is never liable for the loan or a deficiency due to the property being worth less than the loan balance (a non-recourse loan).
Since their introduction, reverse mortgages have become popular; there are presently nearly 500,000 active loans. Originally a refinance only program, the law was revised in 2009 to allow these loans to be used to purchase a new home, so long as the borrower can pay the difference between the reverse mortgage loan amount and the purchase price of the new home.
There are several criticisms of the reverse mortgage program. High upfront costs are an issue and are frequently not properly discussed with borrowers. Interest rates are higher than conventional loans. Pressure sales tactics (including late night TV ads) have encouraged seniors to take out reverse mortgages, spend the money on vacations and gifts, without consideration of the ability to pay and maintain the property going forward.
Some elderly homeowners have been duped by the reverse mortgage/repair scam. An inspector tells an elderly person that he or she need many thousands in repairs or the home will collapse. Many cannot afford these “repairs,” but the scammer refers them to a home equity mortgage lender who arranges the reverse mortgage (even though the repairs are bogus or not necessary), taking huge fees from the unsuspecting owner desperate to fix the home.
Finally, some of the biggest critics are the children, who discover after their parents die that their house inheritance is worthless due to a reverse mortgage debt greater than the value of the home. Because of these issues, and the high default rate of nearly one in ten homes, HUD tightened lending requirements earlier this year to ensure that lenders carefully review borrowers’ financials to be sure they can continue to pay taxes and insurance required on the home. In some cases, loans that used to be granted are now denied, and in other cases the amount loaned will include a required set-aside for payment of taxes and insurance, reducing the amount available to the homeowner.
A reverse mortgage can be a great tool for many homeowners, but it is a program that should be carefully reviewed to ensure that it fits an individual’s needs. Discussions with a CPA, your children and a HUD loan counselor are a must before taking out a reverse mortgage.
Michael J Posner, Esq., a partner in Ward Damon a mid-sized real estate and business oriented law firm serving all of South Florida, with offices in Palm Beach County. He serves as the HUD Foreclosure Commissioner for the state of Florida. They can be reached at 561.594.1452 or by e-mail at firstname.lastname@example.org