Lenders hope to convince financial planners that reverse loans can be a safe, flexible financial tool for seniors. Many planners are skeptical of reverse loans due to their high fees; the industry also has been dogged lately by headlines about litigation focused on foreclosure risks facing seniors, and market exits by several major lenders.
But the reverse mortgage industry is re-focusing on a relatively new lower-cost loan type, which is starting to get traction in the market. They're being marketed as an appropriate backstop resource as part of a broader portfolio of financial options for retirees.
Reverse mortgages are available only to homeowners over age 62. They allow seniors to turn their home equity into cash while staying in their homes. Unlike a forward mortgage, where income is used to pay down debt and increase equity, a reverse mortgage pays out the equity in a home as cash; meanwhile, the homeowner's debt level rises and equity decreases.
The most popular loan type is the Home Equity Conversion Mortgage (HECM), which is administered and regulated by the U.S. Department of Housing and Urban Development (HUD). HECMs are different than traditional home equity lines of credit in two critical ways:
Repayment of a reverse mortgage typically isn't due until the homeowner sells the property or dies.
Borrowers are judged primarily on whether their homes are judged to have sufficient equity to support the HECM. (Until recently, borrowers actually were disqualified from considering other financial qualifications such as personal assets or income; HUD recently issued a rule clarification stating that lenders can consider financial capacity in making their loan decisions, and it's expected that lenders will be adapting their lending procedures accordingly.)
Loan limits depend on the amount of equity in the home and the borrower's age; older homeowners can get more cash. The limit for standard HECMs was boosted from $417,000 to $625,500 in 2009 under the federal stimulus law, a ceiling that has been extended through the end of 2012.
HECMs often are criticized for their high fees. Although lenders often cut these charges to win business, by law they can include an origination fee of 2 percent of the first $200,000 of a home's value, plus 1 percent on the additional value (these fees together can't exceed $6,000). There's also an upfront mortgage insurance premium, or MIP, of 2 percent of the home's appraised value, and ongoing annual MIP equal to 1.25 percent of the mortgage balance. Finally, there are servicing fees, closing costs and other incidental fees.
For example, a 72-year-old borrower with a home appraised at $400,000 could have access to $270,800 under terms of the standard HECM as an initial principal limit — a formula that takes into account the percentage of the home's value based on the borrower's age and the interest rate. In most states, the maximum origination, MIP fees, and other closing costs allowable under HUD regulation on the loan would total a whopping $16,814, according to an analysis provided by the National Reverse Mortgage Lenders Association (NRMLA).
New loan type gaining ground
Standard HECM loan activity has been declining — originations were down 37 percent in 2010, and 2011 is expected to finish as another down year, John K. Lunde, president of Reverse Market Insight. Three big lenders — Bank of America, Wells Fargo and Financial Freedom — announced that they would stop accepting new loan applications, although all will continue to serve existing loans. The reverse industry also has been on the receiving end of litigation focused on the threat of foreclosure against senior homeowners.
Meanwhile, a new lower-cost option introduced last year, called a Saver HECM, appears to be gaining popularity.
Saver HECMs are administered by HUD, just like a standard reverse loan. But the amount that can be borrowed via Saver HECMs is smaller, and they also have far lower costs: an upfront premium of only 0.01 percent of the property's value, or HUD's loan limit, whichever is less, versus the standard loan's 2 percent.
Saver loans are still a relatively small part of the overall market, but originations have grown quickly this year, from 2.6 percent of new loans in January to 7.5 percent in October, according to Lunde. The trend line on Savers actually has been running a bit higher than that, but dropped a bit in October due to the exit from the market of Wells Fargo, which had been writing a high volume of Saver business, Lunde notes. “I'd be pretty surprised if this didn't keep increasing,” he says.
Most Saver HECMs are being issued as adjustable rate lines of credit, with borrowers using them to meet unforeseen expenses. In this sense, they're more like a home equity line of credit (HELOC).
How do HELOCs and Saver HECMs compare? Pricing and interest rates are similar, but there are some important differences.
Retirees often have difficulty qualifying for a HELOC, since they may not have sufficient income to meet lender requirements. And unlike a HECM, the HELOC requires ongoing monthly payments from the borrower. Also, banks can freeze, reduce, or revoke a home equity line if your equity falls too low — and that's just what happened to many borrowers after the housing bubble burst and home values plummeted.
Metlife Bank, which is the industry's largest lender, says 85 percent of the reverse loans it issues are now Saver HECMs with adjustable rates.
In fact, the reverse market may be dividing into two groups — financially-pressed seniors who need standard HECM for their higher loan amounts and lump sum payments, and more affluent seniors using saver HECMs for forward financial planning purposes.
“The Saver client needs less money,” says Peter Bell, president of the NRMLA. “They're using it as a standby reserve.”
Metlife Bank has been pitching Saver HECMs as a Social Security planning tool. The idea is to use the credit line to help meet living expenses in the early years of retirement in order to delay filing for Social Security benefits as long as possible, thereby increasing monthly payments later and enhancing income in advanced age.
Harold Evensky, president of Evensky & Katz Wealth Management, sees the saver HECM as an effective partial replacement for his favorite retiree financial tool: a $100,000 cash reserve. The reserve can be drawn on for living expenses instead of drawing down investment portfolios in bear markets — a strategy that can help make portfolios last far longer into retirement.
However, not all retirees can set aside that much cash. “And there's a big opportunity cost having so much of your assets in cash,” he adds.
That's where Evensky thinks a saver HECM can be useful. “Like most financial advisor, I have been negative about reverse mortgages due to their cost, and felt they should only be used in dire circumstances,” Evensky says. “But the [lower cost of the saver HECM] allows us to create what we're calling a ‘standby reverse mortgage.’ We can reduce the client's emergency reserve to six months,” he says. “If that runs out, you simply tap the reverse and pay it back when things get better.”
Evensky's research team concluded that using a reverse mortgage as a standby resource significantly improved the length of time that the investment portfolio lasted in retirement, anywhere from 20 percent to 60 percent, depending on the scenario specifics.
Mark Miller is a journalist and author who writes about trends in retirement and aging. Mark edits and publishes RetirementRevised.com, which has been recognized by Money magazine. He also writes “Retire Smart,” a syndicated weekly newspaper column, and contributes weekly to Reuters.com. He is the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living (John Wiley & Sons, 2010).