Home equity conversion loans are not the bad boys of the lending world.
There are several common myths about reverse mortgages. Most of those myths, however, are simply the result of a lack of proper understanding of how reverse mortgages work.
Some of the common myths about reverse mortgages can be easily dispelled. Chief among them is the myth that a reverse mortgage is too risky.
People are hesitant to obtain a reverse mortgage for various reasons. Many people may not be aware of the rules that have been put in place to make the reverse mortgage a safe financing option.
A common risk, or myth, that some worry about is that a borrower could end up having to pay back more than the home is actually worth. One of the most important details to take away regarding the most popular reverse mortgage program — the Federal Housing Administration-backed Home Equity Conversion Mortgage, or HECM — is that it is a nonrecourse loan. That means the family or estate will never owe more on the reverse mortgage debt than the value of the subject property.
Spousal protection is another factor now in place that is designed to protect a reverse mortgage borrower. In today’s market, if the senior
borrower is married, both individuals need to be accounted for in the underwriting decision for a reverse mortgage. That was not the case a few years ago.
If the borrower’s spouse is not of qualifying age when the reverse mortgage is taken out, this guideline now prevents the mortgage from being called “due” in the event of the eligible HECM borrower’s death. The nonborrowing spouse must meet specific guidelines to maintain this protection, however. Furthermore, a nonborrowing spouse can remain on the title.
Another major change to the program that protects a borrower is that underwriting re-quires a full credit, income and property assessment as part of determining borrower suitability. This was not the case prior to April 2015. Furthermore, property charges such as taxes, hazard coverage and homeowner association fees are reviewed for timely payments as well. The intent of this guideline is to minimize property tax and insurance defaults and help to ensure the desired loan is a net benefit for the borrower.
Other changes include limitations on accessing funds during the first 12 months of the loan. This rule helps to ensure that the borrower will
have money down the road. Also, the limitation on available proceeds keeps the loan balance from growing rapidly in the early years, thus protecting the future equity position of the borrower.
When the reverse mortgage was originally popularized in the mortgage market in the late 1980s and on through the 1990s, it was often referred to by some as a “bailout loan” or a “loan of last resort.” With limited credit and income documentation, it was essentially an equity-driven product. Although that was not always the case, in many instances, those stereotypes were true back then.
The way that reverse mortgages are used today, however, looks entirely different and the notion that it is a loan of last resort has been retired into the dustbin of history. The primary reason senior borrowers look into a reverse mortgage today is to immediately eliminate their monthly home-payment obligation. This release of cash flow allows reverse mortgage borrowers to instantly free up income for other financial needs, such as medical care, home improvements and entertainment, just to name a few.
“ The reverse mortgage can clearly help seniors secure their retirement, allowing them to age in place with the peace of mind of not having a mortgage payment. ”
Another use of a reverse mortgage is as a purchasing tool to buy a home. Seniors are moving, whether it is to downsize or to be closer to
family, and they continue to be a major force in the home-purchase market. The benefit of being able to sell an existing home and use the proceeds for a downpayment on a new home as part of a HECM for purchase loan — which offers the security of not having a mortgage payment on that new home — is a major draw for senior borrowers.
The senior borrower, by taking advantage of a reverse mortgage on the new home, can often buy more home than they thought they could afford, or otherwise retain key retirement assets for the future. Regardless of the individual reason, the reverse mortgage can clearly help seniors secure their retirement, allowing them to age in place with the peace of mind of not having a mortgage payment.
A common area of confusion, or myth, surrounding a HECM, or reverse mortgage, is that people think it’s the same as a HELOC or a home equity line of credit. A HELOC is another form of credit that uses the home as collateral. A borrower is pre-approved for a certain spending amount based on income and credit scores.
A borrower can draw on this HELOC credit as needed and within the terms of the loan, similar to using a credit card. They are then required to make regular payments for a fixed term.
There are some distinct differences between the HECM and HELOC programs, however. The HECM has a clear advantage over the HELOC in that the borrower is freed from making mortgage payments.
Another myth that should be dispelled relates to the ownership of the home after a reverse mortgage is closed. When a borrower takes out a reverse mortgage, the title for the home remains with the borrower. The bank doesn’t own the home.
The reverse mortgage becomes due once the borrower no longer occupies the home as their principal residence, as the result of death or moving out, failure to pay the property taxes or maintain hazard coverage or, lastly, failure to keep up with general home maintenance. When one of these events occurs, the lender will declare the mortgage due and payable. What has been borrowed, plus interest, is due to the lender at that time, and any equity remains with the borrower.
Many thanks to Mark Reeve for granting me permission to use his article, originally in Scotsman Guide Residential Edition, June 2018