July 31, 2009 - I was contacted recently by a freelance writer who wanted to get some dirt on reverse mortgages. He said he could find people all over the place who could sing the praises of the reverse mortgage, but he wanted to find someone who could give him the pitfalls and things to watch out for. This got me thinking…there are a number of times I do not recommend the usage of a reverse mortgage and there are several things to watch for, but I would not necessarily call them “pitfalls.”
A reverse mortgage is a complex financial transaction and it is not an inexpensive loan, but when used correctly and under the right circumstances, it can greatly enhance the lives of the senior borrowers who obtain one.
So my advice to senior borrowers revolves around education and not the ominous “beware” tone that it appeared this writer was prepared to take.
Choose Option to Meet Need
First, I say to borrowers, "Choose the correct option to meet your needs."
Borrowers can choose a fixed rate or an adjustable rate and fixed rates sound great, but they are what is called a “closed end instrument” and require the borrower to take the entire loan at the very beginning of the transaction.
For borrowers who are paying off an existing mortgage and need all their funds to pay off the current loan, this is no problem. For a borrower who has no current lien on their property or a very small one, this would mean that they would be forced to take the entire eligible mortgage amount on the day the loan funds.
This might give a borrower $200,000, $300,000 or more in cash from the very first day that they do not need at the time and on which they are accruing interest. This can also have an adverse affect on some seniors with needs-based programs.
Seniors on Medicaid and some other needs-based programs would impact their eligibility by having the sudden addition of the liquid assets and the senior would wind up funding their own Medicaid with the equity in their home.
For these seniors, a careful consultation with family members and a financial counselor is advised to be certain that they chose an option such as the line of credit where funds can be made available to them during times of need, but they never have excess funds sitting in accounts to affect their eligibility.
A borrower who is planning on using only a portion of their funds monthly need not pay interest on the entire amount from the very start, eroding the equity unnecessarily fast. An adjustable rate will accrue interest at a much lower rate at today’s rates, but has a 10% cap and can go much higher if rates rise in the future. However, the adjust rate program allows for more options for borrowers to receive their money.
They can choose a lump sum; a line of credit against which they can draw at any time and which cannot be frozen like many of the bank Home Equity Lines of Credit (HELOC’s) are going through now and which grows on the unused portion annually; a monthly payment for a set term or for life; or a combination of all of the options. The adjustable rates are currently much more flexible to meet borrowers’ needs.
One of the things that can determine the amount for which borrowers will ultimately qualify is the rate at which the loan accrues interest. When the margins on the adjustable rates were lower and the fixed rate was higher, the adjustable rates gave borrowers more money in their pockets in the form of eligibility.
Now, most borrowers we run through the reverse mortgage calculator receive more money on the fixed rate program. This is extremely important to know if you are trying to get as much as possible to pay off an existing lien. It also means that the higher the margin, the less money the borrower will receive and the faster interest on the loan will accrue.
So the thing to look for in a reverse mortgage here is definitely the rate on a fixed rate or the margin on an adjustable rate that is being quoted.
Watch for Fees Being Charged
Another thing seniors need to look out for in their reverse mortgages is the fees being charged. The fees are highly regulated by HUD and therefore, the lenders cannot charge fees like processing fees, administration fees and things like that, but there are some things borrowers can watch to help themselves!
First is the servicing fee. The amount of the servicing fee will determine the servicing set aside, which ultimately determines how much money goes to the borrower.
The servicing fee set aside is not a fee at the time you close your loan, it is money that is not made available to you and is left in the equity of your property that is meant to go toward the payment of the monthly servicing fee.
On a regular or forward mortgage, you don’t see this fee, you simply pay anywhere from .25% to .50% higher rate which goes to the servicing company and is built into the rate you pay.
Reverse mortgages use a flat dollar amount instead, and the set-aside is determined up-front due to the fact that the balance of the loan is increasing, not being paid down by the borrower.
The maximum origination fee is set by HUD, but they do not require every lender to charge only the maximum! Check around and see if you might be able to get a better origination fee.
Watch for Long-Term Annuity Pitches
Finally, one of the biggest things for seniors to watch out for with their reverse mortgage has nothing to do with the actual mortgage at all…it’s becoming aware that there are those who are going to try to get you to part with your money!
Do not consider investment strategies which include long term annuities which will not allow you access to your funds for long periods of time without penalty.
Be wary of reverse mortgage originators who seem overly-anxious to help you invest your loan proceeds. Always remember that this is your home equity and with some careful stewardship, it should take care of you but if not guarded, can be taken away, leaving you with a loan on your home and nothing to show for it.
It seems most of the time I see a “reverse mortgage horror story” it is usually due to what happened to the money and not the reverse mortgage itself. With some careful planning by the senior borrowers, getting the family and/or a trusted financial advisor involved and knowing what to watch for, a reverse mortgage can be a viable retirement tool for many borrowers.
It’s just a matter of making sure you put the seniors’ best interest first and knowing what to look out for when doing reverse mortgages for senior homeowners that keep those horror stories from happening in the first place.
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