Strategic reversal
by Kate BavelockIs a reverse mortgage right for you?
It’s a question that increasing numbers of Cape Codders are asking themselves as they reach retirement age with homes that have appreciated in value astronomically over the last decade – even with the recent housing downturn.
“Cape Cod has a larger retirement population than most areas of Massachusetts; therefore the reverse mortgage is more popular in this segment of the state,” said Kirsten Wood of Hyannis Mortgage.
In fact, the 20,000 most highly assessed residences on the Cape begin above $600,000 in value. Many may be owned by people over 62 who are house rich, but cash-flow challenged – facing high property taxes and health-care bills.
With a reverse mortgage, they can spend down some of the equity in their homes while they continue to live there. It is a loan against the value of your home that you don’t have to repay as long as you live there. Payment does not come due until both homeowners sell, move out or die.
Instead of making mortgages payments to the bank to pay off a mortgage loan and increase your equity, it works in reverse where the lender pays you cash and therefore increases their equity in your home.
“Rather than move to raise money, they can stay in their home for the rest of their lives,” said John Alves of American Home Mortgage, based in Mashpee.
Until now, these mortgages have been used mostly by those with little savings for retirement. Others turn to reverse mortgages because of hospital or health-care costs.
However, reverse mortgages are not just for elderly homeowners in pinched circumstances. The money can be used for anything, including travel or remodeling. “Reverse mortgages can even be used to buy a second home if you are over 62,” said Alves.
Brian Drake, of the financial services firm Drake, Saunders and Diwinsky in Orleans, explains that seniors can use a reverse mortgage to implement a financial plan without touching a penny of their investments, savings or income.
He offers these specific examples:
1. Help fund grandchildren’s education.
2. Completely fund long-term care insurance or, if you are uninsurable, establish a little- known hidden strategy to pay for your long-term care.
3. Increase the value of your estate significantly, leaving those assets to your heirs or your favorite charity.
4. Protect yourself against foreclosure or lawsuits.
5. Buy a car, a boat or a second home.
Two major types of reverse mortgages
The Home Equity Conversion Mortgage is backed by the federal government, and the amount is limited to a percentage of the home’s value to preserve some part of the owner’s equity. For example, a $365,000 home would only allow the homeowner to take out $150,000 of equity. The payments can be in a lump sum, a monthly amount, or some combination of both. They are available at lenders approved by the Federal Housing Administration.
Privately owned and backed versions are known as proprietary reverse mortgages. They are usually more expensive, but can also provide larger cash advances for homes of higher-than-average value. The AARP’s Web site has information on software that provides side-by-side comparisons for a homeowner to make decisions on the right lender for their situation.
Risks and disadvantages of reverse mortgages
Reverse mortgages tend to be very expensive when compared with a conventional mortgage. This is due to the rising-debt nature of these instruments, explains Charles Kirkendall, a mortgage expert and author. A typical reverse mortgage may provide a homeowner with a $300 per month payment with a yearly interest rate of 12 percent compounded monthly. Over the course of 10 years, the homeowner will receive $36,000 in payments, but will owe almost $70,000 – almost twice as much as received.
The second disadvantage is the complex and confusing contracts of reverse mortgages that can have a tremendous impact on the overall cost to the borrower. Contracts often allow lenders and third parties involved in arranging reverse mortgages to not fully disclose the loan's terms or fees. These numerous other front-end or back-end fees can also quickly drive up the cost of a reverse mortgage. These fees can include origination fees, points, mortgage insurance premiums, closing costs, servicing fees, shared equity and shared appreciation fees, he cautions.
Kirkendall warns reverse mortgage borrowers to avoid shared equity and shared appreciation fees, which he said can quickly raise the cost of the mortgage without providing any benefit to the borrowers. For example, a shared appreciation fee can give a lender an automatic 50 percent interest in the difference between the current value of the home when the loan is signed and the appreciated value of the home when the loan is terminated. What makes the fees unfair is that they have no relation to the amount that is borrowed.
Another disadvantage: They can affect eligibility for pensions, Medicaid or supplemental Social Security income. Also, a reverse mortgage can reduce the value of a senior's assets and estate. This will affect the amount of inheritance received by the borrower's heirs.
Nevertheless, Kirkendall is not totally bearish on reverse mortgages. He simply provides warnings. “The best way for a senior to avoid these hazards is to be careful when choosing a lender and by obtaining bids from three separate lenders. They should take these contracts to a reverse mortgage counselor for evaluation. This will allow them to accurately evaluate the three contracts before deciding on best one for their situations.”
Drake, a strong proponent of reverse mortgages, considers Kirkendall’s concerns overstated.
“To get a HECM mortgage, counseling through the U.S. Department of Housing and Urban Development is mandatory,” he said. “All HECM reverse mortgage disclosures must be in writing to insure full disclosure. There are no front-end or back-end charges that are not disclosed. There cannot be any hidden fees that can show up later to ultimately increase the cost of the mortgage.”
Drake also points out that rates for a HECM adjusted interest-rate mortgage are closer to 6.5 percent than 12 percent. “There is no indication that rates are going that high in the foreseeable future,” he said.
While a reverse mortgage can affect Medicaid, supplemental Social Security and pensions, Drake said, proper planning can eliminate these problems. “For instance, if one spouse is in a nursing home and the other living at home, a reverse mortgage line of credit will not adversely impact Medicaid payments to a spouse. You can use the line of credit to pay for eligible expenses such as home repairs, appliances, a car, while the nursing-home spouse is still collecting under Medicaid.”
Drake agrees that with a reverse mortgage, the house would represent less equity for your estate. But he suggests that a homeowner in reasonable health can take out a life insurance contract to make up the difference.
Finally, local lenders caution that a reverse mortgage loan can become due early if:
• You allow the property to deteriorate to an unacceptable degree.
• The borrowers move to a new permanent address.
• You fail to meet property taxes and hazard insurance.
• The last surviving borrower moves out for a year or more because of physical or mental disability.
Reverse mortgages in a declining real estate market
Is there added risk based on the recent decline in the real estate market?
Not really, according to Alves. “Cape properties are holding their own, and I don’t see them declining much,” he said.
Equity in the property and its appraised value are the two major components determining the amount you can borrow with a reverse mortgage, he explained. “Other than that, the area sales and values wouldn’t affect the attractiveness of a reverse mortgage, as long as the net figure meets the borrower’s needs,” added Wood.
With rising costs of living and high property values, Alves is betting that demand for reverse mortgages will continue to grow. “It’s going to explode. The number is doubling and tripling.”
Drake, who transacts reverse mortgages, also emphasizes to his clients that they must conduct comprehensive due diligence.
“One prevailing criticism of a reverse mortgage is its closing costs. They can be as high as $16,000 to $18,000,” Drake noted. “That cost may appear high,” he said, “but compared to what?”
“What do you think a four-year college education will cost 10 to 15 years from now? $100,000 or $200,000? What would nursing care or a nursing home cost for three to eight years? Today on Cape Cod, that cost is now about $78,000 per year. Where is the money coming from to pay for this?’” he asked.
Originally published in the March/April 2007 issue of Cape Business
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