Approximately one-third of all Americans own their homes free and clear. Nevertheless, many seniors can end up losing their homes because they don’t have the money to pay their property taxes, or they get hit with high medical bills or encounter a situation in which they need the equity from their home but can’t qualify for a loan.
For many, a reverse mortgage may be a great way to avoid losing their home.
Over the last few years, reverse mortgages have gained a somewhat negative reputation in the real estate community. In some circumstances, however, these can be a tremendous blessing to seniors who may be at risk of losing their homes.
How reverse mortgages work
There are many different types of reverse mortgages. Unfortunately, there are quite a few scams in this area, so seniors looking at this option need to tread carefully. Here’s how the HUD/Federal Housing Administration program works:
"A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash. The equity that you built up over years of making mortgage payments can be paid to you. However, unlike a traditional home equity loan or second mortgage, HECM (home equity conversion mortgage) borrowers do not have to repay the HECM loan until the borrowers no longer use the home as their principal residence or fail to meet the obligations of the mortgage.
"You can also use a HECM to purchase a primary residence if you are able to use cash on hand to pay the difference between the HECM proceeds and the sales price plus closing costs for the property you are purchasing.
"To be eligible for a FHA HECM, the FHA requires that you be a homeowner 62 years of age or older, own your home outright, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan, and you must live in the home."
You could choose to receive your payout as a lump sum, a lifetime monthly payment, a monthly payment for a limited term, a line of credit, or a combination. You would never owe more than the value of the home, regardless of the amount paid out.
Reverse mortgages require points and fees, which often run about 5 percent of the property value. On a $400,000 property, that’s $20,000.
The homeowner must occupy the property as his or her primary residence. If the homeowner becomes ill and is away from the home for more than 365 days, the reverse mortgage becomes due and/or the property must be sold.
When the homeowner dies, the property goes to the lender upon the death of the borrower. In some cases, the property may be sold, provided that both the interest and principal paid by the lender can be reimbursed. If this is the case, then the balance could go to the deceased’s estate.
As a rule of thumb, the younger the borrower is (minimum age is 62), the smaller any monthly payment would be. For more information on reverse mortgages, visit the Federal Trade Commission website.
A reverse mortgage retirement plan: reality or pipe dream?
I recently had a conversation with one of my former colleagues from Southern California who is eagerly awaiting his 62nd birthday so he can get a reverse mortgage. He is a sophisticated investor who has owned (and lost) multiple properties over the years. His game plan for retirement is to do what most investors love to do: work with someone else’s money. Here’s what his plan is:
1. When he turns 62, he will purchase a four-unit building where he will put 40 percent down, owner-occupy one unit, and rent out the other three units.
2. He will then obtain a reverse mortgage, which he will use to pay down the principal as rapidly as possible.
The result: The reverse mortgage refunds his down payment each month while he collects the cash flow from the building. If he lives long enough, he has paid zero for the property since the rents and reverse mortgage will cover the cost of the property plus covering all his living expenses. Since he has no heirs, he’s not concerned about what happens after he dies. While all of this sounds great, there are a host of issues that this individual is not taking into consideration that could spell disaster.
1. Is the mortgage lender reputable?
HUD/FHA is one of the legitimate reverse mortgage lenders. It’s important to verify that any reverse mortgage lender the borrower uses is reputable.
2. Lump sum payments can be dangerous.
A report by the Consumer Financial Protection Bureau found that about 70 percent of all borrowers elect a lump sum payment, oftentimes to handle bills or other emergencies. The challenge is that once the money is gone, the reverse mortgage continues to deplete the borrower’s remaining equity. The result is that if the owners are unable to keep up with property tax increases or their insurance, they can still lose their home.
In fact, the report says that about 10 percent of all homeowners with a reverse mortgage are now facing foreclosure, largely due to the fact that they took lump sum payments. Part of the reason so many people take this option is that the lump sum payment (at least for the HUD/FHA product) is at a fixed rate, while the monthly payment option is at an adjustable rate.
3. A little-known dirty secret.
In many cases where people have remarried, the house may be in one person’s name. In that case, if the person who is on the mortgage dies, the surviving spouse could be evicted from the property.
The bottom line is that reverse mortgages can be a tool to help an owner stay in his property, but they should be considered more as a last resort when all other options have been exhausted.