Reverse mortgages are hot. Baby boom demographics, inadequate retirement funding, and problems in the traditional mortgage market (pushing brokers into alternate products) have combined to make marketing of reverse mortgage products to senior citizen homeowners one of the hottest niches in the mortgage business.
And the effort is paying off for marketers. Federally-insured Home Equity Conversion Mortgages (HECMs) are the predominant type of reverse mortgage in the U.S. Recently, the number of HECMs originated has averaged about 9,000 per month, more than double the average in 2005. Moreover, about two-thirds of the total HECM reverse mortgages ever issued have been originated in the last two years.
Reverse mortgages are only available to homeowners age 62 and older who have paid off their mortgage or have only a small mortgage balance remaining. The sales pitch for these loans is enticing: tax-free retirement income for as long as you own the home – even for life; no monthly loan payments; no repayments until the home is sold, and payment options flexible enough to meet any need! In many cases a reverse mortgage is the ideal tool for senior homeowners.
But there is one big drawback with reverse mortgages: high up front closing costs that can sometimes reach $20,000 or more. Combined with the regular interest that accrues on the loan balance, the up front costs can make this an extremely expensive way to borrow. To spread these costs out and make the cost of borrowing reasonable, it is imperative that the borrower be confident in their ability to remain in the home for at least 5-7 years and, preferably, longer. Unfortunately, government data shows that most HECMs are paid off in seven years or less.
So, while a reverse mortgage may be a good fit for seniors in many situations, it is always important to carefully explore alternatives to see if a more cost-effective means to achieve your retirement financing goals is available.
We discuss below seven alternatives for you to consider:
1. Intra-Family Loan – Do you have a relative or friend with deep pockets and a good heart? An intra-family reverse mortgage loan can be an excellent way to gain the advantages of a reverse mortgage, but avoid most of the costs. The concept is straightforward: instead of a bank lending you retirement funds in exchange for a lien on the house, structure an arrangement with a relative or friend to lend you the money instead – collateralized with your home, of course. You can avoid most of the up front costs this way and have more flexibility to set interest rates and loan terms. There is even a company called Circle Lending (http://www.circlelending.com/familyadvantage/reverse-mortgage.asp) that specializes in drafting these loans as “official” arms length transactions and then provides monthly loan servicing just as a traditional lender would do.
2. Price Appreciation Agreement – There are also firms that will give you money today in exchange for an “equity-share” in the future appreciation of your home’s value. These programs are usually aimed at higher value homes (over $500,000) and may only be available in areas of the country with a track record of strong property value growth. The benefit of these programs is that you may be able to tap into your equity without the high up front costs of a reverse mortgage. The drawback is that it could cost you substantially more in the long run in the form of foregone home appreciation.
If you think this type of arrangement may be a good fit for you, here are two programs to look into to: Equity Key (http://www.equitykey.com/) and, Rex Agreement (http://www.rexagreement.com/)
3. Home Equity Line of Credit (HELOC) – As noted, reverse mortgages make most sense if the homeowner is able to remain the home for seven years or more. The reality, however, is that more than one-half of all HECM reverse mortgages terminate in less than seven years. To finance short and intermediate cash needs, a HELOC loan may provide a more cost-effective way to tap into your home equity. With a HELOC, closing costs are generally minor (sometimes zero). The downsides are two-fold: 1) there are monthly loan payments required and, 2) you will likely need to show the lender that you have adequate income to make the required loan payments.
An “interest-only” HELOC loan typically requires monthly payments equal only to the accumulated interest on the amount borrowed to date. With care it is possible to borrow an amount each month that provides cash for living expenses and is adequate to make the monthly interest-only payment. In this way the HELOC mimics a reverse mortgage with interest building up in the loan balance until the loan is repaid when the home is sold.
4. Delay Receipt of Social Security Benefits – The majority of Americans start their (reduced) social security benefit at the earliest possible age (62). While people may feel it is smart to “get the money while you can”, the truth is that Americans are living longer than ever before and the decision to take early social security can cost you several hundred dollars per month for the rest of your life. People in their seventies and eighties often feel a reverse mortgage is needed to close a budget gap – a gap that might not exist if they were receiving full social security benefits.
5. Sell and Downsize or Rent – Using home equity to help pay for retirement is not a new concept. For generations, it was common for elderly homeowners to sell their homes and use the proceeds to buy or rent a smaller, more affordable dwelling. This remains a viable strategy and one of the best methods available to ensure you get full use of your hard earned home equity.
It is sometimes possible to sell your home to an “investor” and who will then rent it back to you. This provides you with needed cash while allowing you to remain in the home. Investors like this type of transaction since they get a “good” tenant who likely will take good care of the property.
6. Deferred Payment Loans – Many states, local governments and nonprofit organizations sponsor loan programs for the benefit of “house rich, cash poor” senior homeowners. Much like reverse mortgages, these programs lend money today that is paid back when the senior homeowner sells the home or dies.
The drawbacks are: 1) the use of loan proceeds is usually restricted to a specific purpose (e.g. home repair, payment of property taxes or special assessments, etc.) and, 2) eligibility may be restricted to seniors qualifying as lower income.
Deferred loan programs often have very low (even zero) closing costs and interest rates. This which makes them an alternative worth looking into before deciding on a reverse mortgage. To find out what deferred loan payment programs are available in your area, contact the Area Agency on Aging (AAA) for your region (http://www.eldercare.gov/Eldercare/Public/Home.asp).
7. Other Assets – Home equity should be viewed as a financial asset on par with CDs, stocks, bonds, cash-value insurance policies or other investments you may own. Before deciding to “cash out” home equity with a reverse mortgage, compare this strategy to other possibilities like selling other financial assets you may own. Stocks and bonds can be turned into cash much more efficiently than home equity can.
Deciding whether to take out a reverse mortgage is an important financial step for both you and you heirs. Be sure to consider the alternatives before making a final decision.
Tim Paul is a financial management executive with more than 25 years experience. His websites focus on personal finance issues and include:
HELOC loan information and
reverse mortgage information.