Ten Things You Might Not Know About Reverse Mortgages
June 11, 2015
A lot of people have heard the term “reverse mortgage”; however, many people are not overly aware of what exactly they are. In this article, we highlight ten things related to this useful financial product:
- Reverse mortgages are formally known as “Home Equity Conversion Mortgages” or HECMs
- HECMs allow home owners to “tap in to” their home equity. Unlike traditional home equity lines of credit (HELOCs), HECMs are restricted to certain groups of individuals and come with a number of conditions to protect the borrower and the lender.
- HECMs are guaranteed by the government. While that is good in many ways, it does come with a cost. Borrowers must pay several forms of insurance premiums when they have a HECM. The guarantee is not “free”.
- To qualify for a HECM, borrowers are required to undergo formal counseling prior to initiating their loan. While some may balk at this requirement, it is one of the provisions that the government put in place when stepping in to guarantee HECMs.
- To be eligible for a HECM, the youngest borrower must have reached the age of 62. This is a key point associated with HECMs. By forcing the borrowers to have reached a certain age, the lender is able to leverage the actuarial life expectancy tables to provide these loans in a manner that is attractive to BOTH the borrowers and the lenders.
- It is one of the few loans that the borrower does NOT have to repay. OK, a bit of a slight of hand here, while the “borrower” does not have to repay, the borrower’s estate will have to repay! There are only three events that will trigger repayment of the loan while one of the borrowers is alive. The first is a failure to pay taxes or insurance on the home. The second is that the borrowers no longer live in the property or sell the property. The third is that the borrowers fail to keep the property up to FHA standards. HECMs are designed for borrowers that have significant home equity and want to tap in to that equity AND remain in their home.
- You may NOT need to borrow money up front to make a HECM attractive. While many associate the concept of a reverse mortgage to an OTO lump sum payout, HECMs can be structured in multiple different manners. These include initial unrestricted lump sum payouts, initial lump payouts for the purchase of a retirement home, OR opening a “line of credit” against home equity which can be used in the future if necessary. A key point on this last item is that unlike traditional lines of credit, the HECM line of credit will increase over time as inflation increases over time.
- The retirement researchers have found that using a HECM has the ability to make your retirement nest egg last longer. Basically what the research has shown is that the HECM can act as a buffer for your investment portfolio in certain cases. Essentially the HECM can be viewed as providing a larger investment nest egg; and, accordingly, allowing withdrawal rates to be lower. A big disclaimer here, a HECM DOES NOT guarantee that your investment portfolio will be safe. It DOES have the ability to act as a buffer if it is used properly in conjunction with an investment policy statement (IPS) and a well thought out, well implemented withdrawal strategy.
- There is an ability with a HECM to get a guaranteed payment for the life of the loan. Guarantees almost always come with a catch. The one catch here is that you need to continue to satisfy the conditions outlined in number five above. Assuming you do, you can set up what is known as a monthly “tenure” payment. These payments are quite similar to an annuity, with one big exception. You do NOT have to pay a big amount of funds up front to “purchase” the tenure payment. Rather, the actuaries will establish the available tenure payment based on the borrowers age and the home equity. As payments are made, each payment starts building the balance due for the HECM. This balance due accrues interest over time. Between the insurance the borrowers pay and the calculations that the actuaries complete, the lender is protected. This can be a very attractive alternative for certain individuals.
- Heirs will inherit any remaining equity after repaying the HECM. In most cases, heirs are not interested in continuing ownership of the home. When the home is sold, proceeds first go to pay off the balance of the HECM. The remaining funds are then available to distribute according the estate plan.
Is a HECM right for you? That is a question that only you can answer – either on your own or with the help of your financial advisor.
One thing is certain, a HECM is a very powerful tool that has a place in building a solid financial plan. As with all tools, it is NOT the silver bullet. However, it can be very effective when implemented as part of a comprehensive retirement plan.
I enjoy working with folks to help them implement and execute financial plans that allow them to pursue those things in life that are important to them.
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