Many families have a significant portion of their wealth tied up in their homes. In fact, according to the U.S. Census Bureau, the average married couple entering retirement has more home equity than they do liquid assets. As fiduciaries, Jeff and I look at our clients’ entire financial situation when we are working with them to come up with an income plan in retirement. And so, we cannot overlook home equity as an asset that can potentially generate income, particularly for those clients who have limited liquid assets.
That being said, I will sometimes ask a client if he or she would consider what we commonly refer to as a “reverse mortgage.” A reverse mortgage can be used to access home equity. Some reverse mortgages are also referred to as a Home Equity Conversion Mortgage (HECM). A HECM, more specifically, is a reverse mortgage insured by the Federal Housing Administration (FHA).
Unfortunately, the term “reverse mortgage” causes concern among many. Reverse mortgages have long been framed as a quick fix for elderly, cash-strapped homeowners who need money in a hurry. In the past, consumer protections were not as strong as they are now and therefore, some homeowners unwittingly signed up for a product that may not have been appropriate for their situation. A lot has changed over the years.
Some homeowners also falsely believe that if they take out a reverse mortgage, then upon their death, the bank will “take their house.” This is a misconception.
A reverse mortgage is a specific type of home equity loan, available to some homeowners age 62 or older who meet minimum thresholds for home equity. It is a loan (the amount of which depends on a number of factors up to a limit of $679,650 in Massachusetts) against that home equity, that does not need to be repaid until the homeowner sells the home, moves out, or passes away. When that situation arises, either the homeowner, or the homeowner’s beneficiaries, can either come up with the funds necessary to pay off the amount owed, or they can sell the house and are entitled to any amounts paid by the buyer in excess of the amount owed on the HECM.
Some homeowners are hesitant to consider a reverse mortgage because they want to “give their house” to their kids and grandchildren. But this is assuming that their loved ones want that house. It is also assuming that they won’t otherwise have the funds available to pay off whatever is owed on the reverse mortgage. But this may not be the case, especially if the homeowner’s liquid assets have been preserved by using their home equity instead of spending down those liquid assets.
Many seniors with limited or no liquid assets who are living on a fixed income cannot cover their fixed expenses and so for them, a reverse mortgage can be a helpful tool. Reverse mortgages can also help those who want to “age in place” by providing a stream of income that can pay for long-term care in the home.
A HECM can be structured differently depending on whether the reverse mortgage is based on an adjustable interest rate or a fixed rate. Fixed rate mortgage borrowers receive a single lump sum at mortgage closing. Adjustable interest rate mortgage borrowers can select from various plans, including tenure payment, which provides an annuity-like flat monthly payment, or a Home Equity Line of Credit (HELOC), which is available as needed.
The HECM program has specific requirements a homeowner must meet to qualify. He or she must be 62 or older, and must either own the property outright, or have a small enough mortgage balance to pay it off with the reverse mortgage loan. The homeowner must also occupy the property as his or her primary residence.
The home must be a single-family home, or a four-unit maximum multiple family home with one unit occupied by the homeowner. Condos and manufactured homes are eligible as long as they meet FHA requirements. Additionally, a homeowner must have their federal taxes paid to date, and must have the ability to continue to pay property tax and insurance, and any other applicable homeowner fees.
As I mentioned above, there have been some recent changes to the HECM. Those changes increased initial mortgage insurance premiums and tightened lending limits. This is worth noting, because these changes were made to protect borrowers.
Reverse mortgages do incur fees, including the mortgage insurance premiums, which the borrower is on the hook to pay. So, it is important to understand them. Generally, I am not opposed to paying a fee for a product or a strategy if the fees are reasonable and the product or strategy that I am paying for provides an appropriate solution to a problem. Therefore, I asked my friend, Scott Liebkemann, of Slade Mortgage in Falmouth, to explain generally the types of fees that are charged and why they are incurred.
“The costs and fees associated with a HECM can vary based on many factors…the value of the home, the amount of any existing lien, and the lender you choose to work with. The costs fall into three categories. The first is the one-time third party closing costs (attorney fee, appraisal, recording fees, etc.) associated with any refinance transaction, typically in the $3,000 range. Second is the mandatory FHA mortgage insurance, which is two percent of the home’s current value. This is in place to protect the borrowers and their heirs from owing more than the property is worth. That is the largest cost. The third is the origination charge, which is typically negotiable. We have found with all of our clients that the benefits of the program far outweigh the costs. The most important thing is to consult a local professional that you trust, as you would with any major financial decision.”
There are many factors to consider in determining whether or not a reverse mortgage is appropriate as part of an income plan, and as I said at the outset, not everyone qualifies for a reverse mortgage. That’s why it’s essential to consult with your financial advisor and a knowledgeable loan officer to understand what’s involved.
As Jeff always says, be vigilant and stay alert, because you deserve more.
Have a great week.
Susan Roman is an Investment Advisor Representative at Cutter Financial Group, LLC, a wealth management firm with offices is Falmouth, Duxbury, and Mansfield. Susan can be reached at firstname.lastname@example.org.
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