How Did Reverse Mortgages Get Such a Bad Reputation?
Before discussing how reverse mortgages can fit into your retirement income plan, it is worthwhile to first consider in greater detail the bad reputation reverse mortgages have developed. Some aspects of that bad reputation are based on misunderstandings, some aspects were true in the past but have since been mitigated, and some aspects may still remain.
Recent research published since 2012 is gaining new adherents for reverse mortgages, including myself, but this retirement income tool still retains a bad reputation with much of the public and significant portions of the financial services industry. Its reputation is not helped by the seeming surplus of late-night commercials and spam email advertisements generated for these products.
One initial point to make is that when considering a reverse mortgage, it is important to be responsible with the strategy and to not give in to the temptation of treating the reverse mortgage as a windfall to be spent quickly and enjoyed. This point cannot be overemphasized enough, as the natural tendency may be to spend assets as soon as they become liquid. If you’re aware that you lack sufficient self-control, you should be careful, but for responsible retirees it is another matter.
Part of the reason reverse mortgages have developed a bad reputation is because of the temptation they provide to more quickly deplete your asset base, creating financial hardships for later in retirement. Recent government changes have been designed to encourage more responsible use, but in many cases, the compensation for loan officers originating these mortgages still may be linked to the initial borrowing amount. For this reason, loan officers may suggest taking more out sooner. Consequently, borrowers should seek a loan originator who is not compensated based on the initial lump-sum amount taken from the loan.
Troubles regarding reverse mortgages are summarized in the following table. Some of the troubles relate to misunderstandings, such as the idea that the lender receives the title to the home, or simple miscommunication among family members about future inheritances.
Other troubles relate to real problems which have since been corrected by new HUD regulations. Some of these problems include concerns about withdrawing too much too soon, the potential problems confronting non-borrowing spouses, and foreclosures for desperate borrowers who could not keep up with their property taxes, homeowners insurance, and home maintenance requirements.
Other problems have been addressed by the government, though these issues are not necessarily fully resolved. For many lenders, there is still a notable cost involved in initiating a reverse mortgage, though these upfront costs have been reduced in recent years and some smaller lenders now offer very low upfront costs. I also have concerns about whether the mortgage insurance premiums collected by the government will be sufficient to cover the non-recourse aspects of the reverse mortgage.
I outlined some of the more prevalent factors leading to the bad reputation of reverse mortgages below:
Use Reverse Mortgage Too Quickly for Questionable Expenses
In the past, retirees sometimes opened reverse mortgages in order to immediately spend the full amount of available credit, possibly either to overindulge irresponsibly in unnecessary discretionary expenses or finance shady or sometimes fraudulent investment or insurance products. This jeopardized the role of home equity as a reserve asset for the household.
HUD requires a counseling session and has enacted new rules to discourage taking too much too soon from the available line of credit. As of 2015, the mortgage insurance premium increases from 0.5% to 2.5% of the home value if more than 60% of the available proceeds are withdrawn in the first calendar year. As well, more than 60% of the available credit can be spent in the first year only for particular qualified expenses such as to pay off an existing mortgage or to use the HECM for Purchase program.
The media has reported about adult children who are surprised they will not inherit the house because their parents used a reverse mortgage.
Such media reports are typically based on misunderstandings on the part of angry children. Articles focus on one aspect of inheritance (the home). Children can pay the loan balance and keep the home. Recent research clarifies that strategic use of a reverse mortgage to cover a fixed retirement spending need is actually more likely to increase the overall amount of legacy wealth available to children at the end. One must also consider whether the parents’ assets were best used to meet their own spending goals or provide a legacy for their children.
In the past, younger spouses were taken off the home title to allow a reverse mortgage to proceed and were then surprised when the borrower died and the non-borrowing spouse faced either repaying the loan balance or leaving the home.
As of 2015, new protections are in place for these non-borrowing spouses. They can remain on the home title and stay in the home even after the borrowing spouse has passed away. Though non-borrowing spouses cannot borrow more from the line of credit, they are now able to remain in the home. Lending limits will be based on their age to help protect the insurance fund. Eligible non-borrowing spouses no longer have to worry about loan repayment until they have otherwise left the home.
A commonly held false belief is that the lender receives the title to the home as part of a reverse mortgage.
This is simply untrue. It is an enduring myth about HECM reverse mortgages.
Reverse mortgages were taken out by those who were unable to keep up with their property taxes, homeowner’s insurance premiums, and home upkeep, often resulting in a default that triggered foreclosure.
As of 2015, a financial assessment is required to ensure the borrower has the capacity to make these payments. If other resources are not available, set asides will be carved out of the line of credit to support these payments. These set asides do not become part of the loan balance until they are spent, but they do otherwise limit the amount one can borrow from the line of credit. Nonetheless, to the extent that the liquidity from the reverse mortgage leads to a behavioral issue of overspending, this is a concern for potential borrowers with limited self control.
Foreclosures for the elderly generated by the inability to meet technical requirements of the loan created negative media coverage and a misconstrued view of the HECM program.
New safeguards have been added, but it is important to keep in mind that such retirements were not sustainable in the first place. Reverse mortgages may have still created net positive impacts for the households as their living situation could have otherwise worsened much sooner. Monthly repayments are not required for reverse mortgages, so non-payment of the loan would not trigger foreclosure. The reverse mortgage actually may have helped delay what was ultimately inevitable.
Reverse mortgages are expensive to initiate.
In the past, the initial costs for opening reverse mortgages could be as high as 6% of the home value. These upfront costs have been reduced dramatically for competitive lenders, and today it is even possible to find opportunities to offset initial origination costs with a higher lender’s margin interest rate.
Nonetheless, HECM loans originated today will include an unavoidable 0.5% upfront mortgage insurance premium. That adds up to $500 per $100,000 of appraised home value. There will also be other closing costs for home appraisal, titling, and other matters similar to traditional mortgages which cannot be avoided. This being said, many lenders may charge the full allowed amount for origination charges, and consumers must shop around. Unfortunately, there are currently no easy ways to compare offers from different lenders.
One may worry about taxpayers being on the hook if the mortgage insurance fund is overburdened by non-recourse aspects of the loans.
Reduced housing prices in the 2000s created problems which were addressed by the Reverse Mortgage Stabilization Act of 2013 to help make sure insurance premiums and lending limits were sufficient to keep the insurance self-sustaining. Nonetheless, this situation may not be fully resolved at the present, especially when interest rates are currently low and may rise in the future.
Stigma About Using Debt
Psychologically, individuals may be challenged by the idea of using a debt instrument in retirement after having spent their careers working to reduce their debt.
This is a psychological constraint against using reverse mortgages. Generally, if one thinks about the investment portfolio and home equity as assets, then meeting spending goals requires spending from assets somewhere on the household balance sheet. In this regard, spending from home equity should not be viewed as accumulating debt any more than spending from investment assets should be. A reverse mortgage creates liquidity for an otherwise illiquid asset.