Reverse Mortgages

A Reverse Mortgage Is Not Such a Strange Concept

The idea of a reverse mortgage may confuse some people a bit. The term might be confusing, but the actual lending product is really not that complicated. There are a few key differences between a mortgage and a reverse mortgage though, and it always is wise to have a good understanding of what you are getting into with any loan, especially when you are putting your home on the line.

In spite of regulators going the extra mile to try to ensure that borrowers sufficiently understand how these things work, the majority of people who hold a reverse mortgage freely admit that they do not understand this product very well. The fact that we do not achieve at least a reasonable level of confidence with borrowers tells us that the present means of educating them or ensuring they get independent legal advice isn’t working all that well to achieve its desired result.

Reverse MortgageForcing borrowers to get independent legal advice isn’t particularly helpful in most cases, as this is almost always just an overlap with the current regulation. It is only when there are legal consequences apart from the reverse mortgage itself that need to be considered that independent legal advice should be needed, as reverse mortgages are both standardized and transparent in their form at least.

While the legal consequences may be standard, whether or not a reverse mortgage is the best choice for borrowers based upon factors like financial need or whether another type of loan may be better suited to the borrower’s circumstances is another matter entirely, and the meat and potatoes of the discussion really, but these are not things that we may expect a lawyer to help us with very much, since this is all outside their field.

We may certainly expect the lender’s agent to go over some of this with us, the good parts at least, although they will have a natural bias as they are compensated for the sale in some way, and therefore their job is to portray reverse mortgages in a favorable light. This is the case with any potential arrangement with a financial institution though, anything from getting a conventional mortgage, buying insurance, getting a loan, buying investments, and everything else that financial institutions offer.

If the threshold here should be higher than a conventional mortgage, and perhaps it should be given that conventional mortgages are better understood by the public, we should focus on requiring them to get independent financial advice rather than independent legal advice. We have this requirement already in certain situations with other lending products, such as with someone who has in interest in the property opting out to be given access to a secured line of credit, so this isn’t unique to the lending business but making it mandatory certainly is.

This adds to the closing costs of the deal, and these are situations where the borrowers tend not to be particularly wealthy and are looking to tap into their home equity to make their retirement years more livable, where an extra $500-$700 will tend to matter to them, Closing costs are already higher than with a conventional mortgage, so we may not want to add to that burden unless really needed, and this really isn’t in the vast majority of cases.

Getting Clear on the Costs and Benefits Involved

A big part of the problem is that, while borrowers do understand the benefits well enough often times, as is the case generally, the terms and conditions that address the other side of the ledger, those which protect the lender’s interest and other key things that borrowers need to be aware of are buried in the terms and conditions, which few people go over closely and even fewer properly understand.

An example of this lack of understanding would be back when, in the United States, it was common practice to demand that the loan be repaid if one of the borrowers dies. This left the surviving partner out in the cold, where the home would need to be sold and they would now need a place to live. In many cases the survivor would not have the means to do so, and since they may not have been aware of this condition, they may not have prepared for it either.

This has been resolved though through regulation and now both parties need to die before the lender can swoop in and demand payment for the loan. We still do see a lot of foreclosures while the borrowers are still alive though, at a rate of around 12% in the U.S. presently, and these happen when the borrowers can no longer keep up with their property taxes and home insurance.

Lenders do take measures to manage this risk, and in spite of our not needing to ever pay back the loan while we are still alive and still living in the home, lenders do treat this like an amortized loan where one’s credit history has to be satisfactory, there cannot be a history of recent missed payments on credit products, and they also need to have sufficient income to meet these property related expenses over time.

If you cannot make your property tax payments though, with or without a reverse mortgage, you are going to be risking disclosure anyway, and if the reverse mortgage is structured and managed properly, it should actually reduce the likelihood of this happening, not increase it.

The insurance payments do add to the cost, and just about everyone has it anyway, but it should not be so burdensome in itself as to risk default, and those who are at particular risk are screened out.

Banks only use basic formulas when calculating our capacity to repay loans though, allotting what they consider to be a reasonable portion of one’s income to personal expenses, but these expenses can vary a lot and circumstances may arise that may cause real problems. For example, if one of the borrowers becomes institutionalized due to poor health, or other situations that involve significantly higher costs to the borrowers than was anticipated, this can cause them to not be able to keep up with these payments and lead to foreclosure.

Understanding What We are Getting into with a Reverse Mortgage

Once again though, we need to compare situations with and without the reverse mortgage to understand what impact it may have, if any, and it is not enough to just cite the current 12% foreclosure rate without considering what it would be otherwise. It might even be that this rate would be higher if not for the reverse mortgage, which in itself does not impact borrowers materially while they are alive aside from the insurance requirement if no insurance was held otherwise.

The approach used in the United States is to require that borrowers take an accredited course prior to receiving a reverse mortgage, and while this may indeed foster a better understanding of the product, we need to realize that it is unforeseen circumstances that are usually the culprit when reverse mortgages turn bad.

If the surveys show that borrowers admit they do not understand this all enough in spite of taking a course, that should tell us that there still may be a bridge left to gap.

The role of regulation here isn’t to decide for people what the best decision for them would be financially, it is to ensure that things are transparent enough so that those involved are in a position to make informed financial decisions. The test for this is to observe the incidence of where a lack of understanding ends up causing a material change, for example not knowing that they could lose the home if one of the parties die back when that was common, or not realizing that they could lose the home by getting behind on their property taxes or not keeping up with the insurance payments.

These situations can be better addressed by offering borrowers a shorter and simpler version of the terms and conditions than what we have now, the lengthy, complicated, and difficult to understand verbiage that the lender’s lawyers have written, not for the benefit of the borrowers but instead for the judiciary should legal disputes occur, with distinctions and covenants far beyond the common use of language.

Other than that, borrowers are on their own anyway, but this is the case with conventional mortgage as well and anything else that you would get from a financial institution. Regulation may protect you from being deceived or not properly informed by lenders, but they do not protect you against yourself or against various circumstances that may arise. As long as you properly understand how things work and what your obligations are, that is as far as this road goes.

There is certainly a lot of potential to misuse reverse mortgages, and far too often this is viewed as a windfall of sorts by borrowers rather than an opportunity to improve their retirement prospects and way of life. This is not something that regulation is equipped to handle though, just like it isn’t with our spending generally, and we can get ourselves in trouble all we want beyond the basic understanding of what is required of us to maintain things in good standing.

When used properly, reverse mortgages do offer some real benefits, and some unique ones as well. Reverse mortgages get their name from the fact that they do the opposite of what a mortgage does, which amortize over time. As time goes on, the principal balance of a mortgage decreases, but with a reverse mortgage, it increases, and also increases at an accelerated rate due to compounding.

For those who are familiar with how bonds work, this would be like selling an interest at maturity bond to someone, where you get a lump sum payment, repay both the principal and all accumulated interest at maturity. Maturity with a reverse mortgage generally occurs when the borrowers die, but they also have the option to close it out by selling the home, or it may be closed out for them if they do not meet their obligations.

This is not just like turning over your home ownership to the lender for a lump sum, which is one of the points of confusion with borrowers, no more than you would when you take out a conventional mortgage. It is also not about not needing to make payments like you would with a mortgage, although this is somewhat true as there are no payments required on the loan itself, although we still need to pay our taxes and keep up with insurance payments.

Providing that we may benefit from the loan, which we can assume is the case since people don’t borrow for no reason, the decision then comes down to whether we want to raise these funds by way of just selling the home, taking out a regular mortgage, getting the money from a home equity line of credit, or going with a reverse mortgage.

The rates for reverse mortgages are a little higher than with conventional mortgages, similar to home equity lines of credit, but this is to be expected given that we are making the lender wait many years to see any money out of this. There are also some additional risks to the lender, such as the loan balance exceeding the value of the home, but in the United States, this is now being covered by a government insurance scheme which the borrower pays into and will make up for any shortfalls in the end should there be any.

Reverse Mortgages Can Add a Lot to Our Retirement Years

The reason why reverse mortgages are as popular as they are is that they offer much more security for the borrower, as provided they keep up with property taxes and homeowner insurance, things they would be doing anyway, they get to live in their home for the rest of their lives no matter what. The money they receive can be used for any purpose, from spreading it out over your lifetime by using it to purchase an annuity, to spending it all at once without any concern for the future.

Conventional mortgages and even secured lines of credit both involve making payments over time on money borrowed, which borrowers may not be comfortable with or may not be able to afford. Many retirees are struggling enough to make ends meet already, particularly the ones that seek to borrow more with a product such as a mortgage, a line of credit, or a reverse mortgage, and not having to make payments on the loan they want can not only be appealing, but sometimes necessary.

This is especially the case given that seniors are more prone to health issues that can significantly impact their ability to repay a loan, and while there is still a risk of this happening with a reverse mortgage, the risks are considerably lower since the payments required by a reverse mortgage are also required with other products, and amounts added to pay down the debt significantly increase the overall obligation.

How well this ends up working for us will depend on how wisely we spend the money, and this becomes a matter of calculation and deliberation on the part of borrowers, and we can do this wisely or foolishly depending on how we choose. Using it to buy an annuity is an obvious good choice in many circumstances, and if we have present obligations that take precedence, we can use some of the proceeds for that and invest the rest into what amounts to additional pension money for us.

The combination of a reverse mortgage and a life annuity can be a good plan indeed, where we both secure the ability to live in our own home for the rest of our lives and also receive additional income for the rest of our lives.

This idea is one that many find very appealing, although it isn’t really promoted to them enough and they generally have to get independent financial advice to arrive at this conclusion.

Given that this is a big decision, discussing a reverse mortgage with a qualified financial advisor is well worth the expense, especially with those whose understanding of such matters is less than sufficient.

We also need to be sufficiently aware of the terms and conditions, including how much we can borrow, other eligibility requirements, the interest rates, how this interest compounding will affect things, what happens when we die, and so on. These are all things that the lender can provide and are required to, but we need to ensure that we understand them properly prior to taking out such a loan.

In the right circumstances, and when used properly, a reverse mortgage can be a fabulous idea that offers some very unique benefits that may be perfect for many people who are looking to tap into some of the equity in their home without having to worry about paying it back.

Reverse Mortgages FAQs

  • Are reverse mortgages worth it?
    Reverse mortgages provide homeowners with the opportunity to borrow against the value of thier homes without needing to worry about making loan payments or risking foreclosure if they are unable to make them. Since there are no payments to make, qualifying is much easier than with a regular mortgage. Reverse mortgages therefore do have their place.
  • What banks do reverse mortgages?
    Several big banks offered reverse mortgages up until 2012 when new regulations made this more difficult for them. There are still some regional banks that offer them but this market has been taken over a lot by non-bank lenders such as Quicken who have also made serious inroads into the traditional mortgage lending market as well.
  • Can you lose your house with a reverse mortgage?
    While reverse mortgages do not require any payments while you still live in the home, you can still lose your house by way of foreclosure if you cannot keep up with the property taxes, home insurance, or home repair. The lender has the right to force the entire payment amount to be due, resulting in a foreclosure and the sale of the home to pay this off.
  • What happens to reverse mortgage when you die?
    A reverse mortgage comes due when the homeowner dies, although with a couple, you can set both up on the reverse mortage so that the mortgage is maintained until both parties die. Once the borrowers die, the home becomes estate property and the mortgage is settled at the estate level, where it may be paid off by other assets or from the sale of the home.
  • Who owns a house with a reverse mortgage?
    With any mortgage or other secured loan, including reverse mortgages, borrowers retain the title to the property unless the lender steps in and takes it away from them, known as a foreclosure. When the lender takes possession, they can dispose of it as they wish, and will force a quick sale so that they can recover their financial interests in it.
  • How much money do you get from a reverse mortgage?
    There are a number of conditions that determine how much you can get from a reverse mortgage, including your age, where you live, the value of your home, the amount of any liens on the property if any, and interest rates. There are several online calculators that can give you a good idea of how much money that you can expect to get.
  • How long do reverse mortgage payments last?
    Homeowners can either choose to take the proceeds of their loan with a reverse mortgage in a lump sum or choose monthly payments over a certain number of years. Borrowers can also take out a lump sum and purchase an annuity with the money which can also provide them with a steady stream of income, which they can choose to receive for life if they wish.
  • What is the down side of a reverse mortgage?
    Many people choose a reverse mortgage to supplement their income, meaning that they aren’t making enough to make ends meet or to meet future financial challenges. When the money runs out, they may be placed in a bad position where they can no longer keep up the costs of home ownership and lose the home, although they may have lost it either way.
  • Can I sell a house with a reverse mortgage?
    Selling a home with a reverse mortgage isn’t that much different from selling a home with a mortgage, other than the sale always concludes the deal with a reverse mortgage, where with a traditional mortgage you can port it to another property. Provided that you can pay off the balance due on the reverse mortgage, there are no real issues with you selling the home.
  • Can you get a lump sum with a reverse mortgage?
    Getting a lump sum payment with a reverse mortgage is definitely a possibility and can be preferable in some cases. If you don’t trust yourself or you want to ensure that the money will last for a certain amount of time, you can collect the loan proceeds in installments over time, but you can also invest the lump sum in an annuity and extend the payments for life.
  • How are reverse mortgages paid back?
    Reverse mortgages are almost always paid back by way of the sale of the home, and almost always upon the death of the borrowers. People who take reverse mortgages rarely have other assets that allow them to pay off the reverse mortgage and stay in the home, and need to continue to live in it to avoid increasing their housing costs too much.
  • Are heirs responsible for reverse mortgage debt?
    Heirs are not responsible for debts of the deceased in general, and this includes with reverse mortgages. In order to be held liable for debts, you must be named as a debtor or potential debtor in the lending agreement, and this has nothing to do with being a family member or an heir to the estate. The estate of the deceased is responsible for it though.
Robert

Editor, MarketReview.com

Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.