Reverse Mortgage Websites

Kiplinger's recommends: www.goldengateway.com to do the math and I recommend also the AARP site: www.aarp.org/revmort/ for an estimate of benefits based on age.

The older you are, the more the monthly payments you receive but the less time you may have to amortize closing costs over your remaining life.

Upfront costs could be from 4%-6% but over the life of the loan could be as much as 10% so it is wise to run the numbers with a financial planner and consider other solutions that may be less expensive.

Interest rates may be variable and in this environment may end up going up and costing you more and depleting your remaining equity faster than you had thought. A fixed rate would be preferred, especially when interest rates are low.

Federal (FHA) loans provide limitations on variable interest rate changes where a private loan may not have these safeguards:

(1) Rate changes cannot occur more than once per year
(2) Change is only based on the 1-year Treasury bond rate change
(3) Maximum change of 2% in any year and maximum of 5% point change over the lifetime of the loan

The most complete list of HECM lenders, per the AARP report, can be found at:

www.hud.gov/offices/hsg/sfh/hecm/hecmhome.cfm

Pros and Cons of Reverse Mortgages (HECM)

Remember that there are other alternatives to boost income if needed later in retirement than a reverse mortgage. An intra-family transfer to a child or just obtaining a HELOC (home equity line of credit) may be good possibilities.

PROS:

(1) Provides financial independence
(2) Can stay in the home you love
(3) No loan payments required - you get money instead
(4) Reverse mortgage does not have to be repaid until last surviving borrower dies or home is sold or borrower moves out permanently (but, of-course, then the monthly income stops)
(5) Non-recourse (big, fancy term but what it means is that you can never owe more than the home is worth so you never have to worry about other assets being at risk)
(6) Many options of payments (lump-sum or monthly payments or a credit line that you use as you need to)

Now for the CONS:

(1) Can't do it unless your home is free and clear (otherwise proceeds must go first to paying off the current mortgages leaving less for you, but it could save you that mortgage payment)
(2) It is costly to obtain (total closing costs can be 6-10%), therefore, the less time you do end up living in the house due to health issues or death, the more costly the loan to you (you need time to spread those costs)
(3) If you live in an expensive area (like the DC area) you most certainly won't be able to get all of your equity
(4) All borrowers must be at least 62 years old
(5) The interest rate is continually added to the amount borrowed so it is possible that no equity will be left for heirs to inherit.
(6) Private loans may allow you to borrow more but are more costly and may, again, deplete your remaining equity quicker leaving no legacy values to inherit
(7) Heirs may be able to help with income needs at a lower cost and maintain the inheritance and at a much lower cost


Again, because interest is added to the outstanding balance borrowed it is very possible that further home appreciation (or in a market like we have been with depreciating values) will not keep up and you may not have much, if any, home equity to leave to anyone or to use to pay for long-term care (or other bills) if you need to vacate the home.

FHA Limits on Reverse Mortgages

Although you can obtain a reverse mortgage privately, FHA provides a level of safety as it is government regulated.

FHA has a maximum amount that can be obtained as a reverse mortgage, calculated as follows:

(1) This must be the first mortgage (so others must be paid off before-hand or with the proceeds)

(2) For each year over age 62, the formula limit is increased approximately 2%

(3) Rate used is based on 10-year Treasury rates

(4) The low interest rates (in the 2010 market place) provide for a higher amount available to borrow than in high interest rate environments

NUMERATOR:
(5) [ (Appraised home value or FHA maximum for your area) x (1 + CPI rate)^ Client's remaining life expectancy] . . . in this formula the symbol ^ means "raised to the power of" (for example, 20 if you were 75 years old)

DENOMINATOR:
(6) [ (1 + 10-year Treasury Rate) + (FNMA spread, which has been 1.5% but does change) ]

For example, a $300,000 house for a 75 year old with 3% expected growth rate in CPI and 10-year Treasury rates of 3.5%, results in slightly more than $200,000 available for a reverse mortgage.

Closing costs can be 4% or more of the loan and can be paid from proceeds but are most likely lower than closing costs on the private market.

I still believe that there are only rare instances where this is the better alternative than other options (see other posts in this blog under: Debt-Mortgages) but it can work.

HECM = Home Equity Conversion Mortgage

Home Equity Conversion Mortgage is the official phrase for "reverse mortgages". Here are some highlights:


(1) All borrowers must be at least 62 years old

(2) You must use your personal, primary residence

(3) Reverse mortgage must be the "first mortgage", so any existing mortgages must be paid off

(4) TALC = Total Annual Loan Cost are expensive (the fewer years in the home the more costly)

(5) Closing costs include "up to" 2% broker's commission (but this can be negotiated)

(6) If using FHA, then another 2% mortgage insurance premium is a part of closing costs; now we are up to 4% front-end costs

(7) Balance, plus interest, must be paid within 9-12 months after the borrower vacates the property (as a result of moving to an assisted-living facility, death, or sale)


This is an expensive means to an end and can result in significant degradation in the equity in the home and potential value for heirs to inherit.


It is important, therefore, to seriously consider the alternatives to obtaining a reverse mortgage to meet immediate income needs, for example:


(1) Sell the house instead and downsize
(2) Adult children "gift" money to the parents to meet income needs (protects home value)
(3) SSI = Social Security Supplemental Income (available if very low income)
(4) Size of the reverse mortgage (only obtain what is really needed to meet basic income needs)
(5) DPL = Deferred Payment Loans for repairs (in effect, a regular HELOC or mortgage though you do have to make monthly payments instead of receive monthly payments)
(6) PTD = Property Tax Deferrals (some counties waive property taxes based on income and assets owned outside of the home's value)...I will write more about this separately.


AARP has a very nice brochure called "A Consumer's Guide to Reverse Mortgages".

Questions Posed to Kiplinger's Magazine Part II

The second question posed to Kiplinger's in the March 2010 issue that I did not like the answer to is: "...I'm finally ready to buy a home. How much cash do I need?..."

Kiplinger's answer explained that 5% down is needed for a conforming loan (up to $417,000) and 10% if a larger mortgage is needed. 20% down is needed to avoid Private Mortgage Insurance but only 3.5% is needed to consider a Federal Housing Administration (FHA) loan. Another 2% to 7% will be needed for closing costs.

Now my "real" answer:

What Kiplinger's stated is correct but off the mark. The amount of cash you need is dependent upon your household income. Don't let a mortgage banker or Realtor tell you what you can afford. See an independent financial planner.

If you are in your "earning years" for the next 35-40 years, then no more than 28% of your gross income should be spent on the mortgage (principal, interest, taxes and insurance). In some areas of the country, maybe you could stretch this to 31%, but Dave Ramsey (another radio and TV personality) suggests no more than 25% of disposable income.

So, the amount of down-payment has nothing to do with the answer to this question of how much you need.

Determine the amount of the mortgage you can afford first and then back into the down-payment. If you don't have the cash required without depleting your emergency funds then purchase a smaller home or continue to rent.

Reverse Mortgages

The National Consumer Law Center (r) (http://www.consumerlaw.org/) prepared an interesting white paper in October 2009 entitled "How Reverse Mortgage Lenders Put Older Homeowner's Equity at Risk".

CONCLUSION

(1) Senior advocates and policy makers supported the creation of reverse mortgages as a means to help seniors

(2) The Home Equity Conversion Mortgage (HECM) is federally insured and has been a lifeline to cash strapped seniors who need additional income since its creation over 20 years ago. (Yes, this option is not new and has been around for quite some time)

(3) But today, the consumer protections built into the program are being eclipsed by the drive to exploit senior home equity by major banks, insurance companies, mortgage brokers, and Wall Street investors.

(4) Sophisticated sales campaigns designed to maximize loan volume...threaten the financial well-being of America's seniors.

Bad advice and reverse mortgages provided by private insurers who are selling overpriced and inappropriate financial products make conditions where the entire home equity is gone too quickly or lost in some other venture. As with so many things, what started out as a good idea has been distorted. I will write more about reverse mortgages.

Short Sales in Real Estate

"...A real estate short sale is an agreement with a lender allowing for the sale of a property to a third party for less than the amount owed on the mortgage. Under this agreement, the lender accepts less than the amount owed and releases the borrower from the mortgage, thereby preventing foreclosure..." (definition)


The key to this talk about a "short sale" is that the borrower/owner must really be in distress. A short sale most likely would not work if you are not seriously behind on the mortgage payments and you still have income (no job loss or other complications). The bank then is under no pressure to accept a deal if you can afford the mortgage.


For those in this situation though, it used to be that the amount forgiven by the bank was "taxable income". Effective with a law passed in December 2007 (due to the sub-prime mortgage issues) the forgiven debt is not taxable for sales over the next few years (it is not a permanent change and is related only to housing sales). See the IRS site for more details.

Buying a House is More Expensive Than You Think

Money "lost" to taxes is the same as money "lost" to interest. If it costs you $10,000 in interest and real estate taxes to save $3,000 in taxes you are still "out" $7,000.

Only the appreciation on a home helps you overall in comparison to renting and the average appreciation on homes over the past 30+ years has been about 1.1% greater than the inflation rate. So, as an investment, a home is no way to build wealth. It is and always should be considered a place to live. Owning is better than renting if you plan to stay in the home long enough to reap the benefit of this appreciation.

People are quick to not buy a mutual fund with a front-end load of 5.75% (because no-load funds are so readily available) but a home carries a much higher front-end load than this and a back-end load, too. That is, the closing costs, prepaid interest, taxes and sales commissions. To buy will cost 10-12% and to sell is another 6-10% (including moving costs).

That cost alone is then about 20% of the home purchase. With inflation at 3.5% and maybe average appreciation of 1.5% (to be kind, but I expect the next 4-5 years will be difficult), you can see that it would take 4-5 years just to cover your costs with appreciation, even net of the tax benefit.

The key to living anywhere (and I do believe that everyone who can, should eventually purchase a home) is to not spend more than 25%-28% of your gross income on P+I+T+I (mortgage payment) or rent.

Subprime Needs to be Kept in Perspective

According to Deutsche Bank’s Mike Mayo:

Currently, of the $10 trillion in U.S. home mortgages, some $1.2 trillion may be regarded as subprime...

This is very interesting to me as it affects the economy. Many large banks and brokerage firms are announcing major write-offs of billions of dollars of bad debt on mortgages but the totals are amounting to less than $120 billion for all of them. Maybe it amounts to twice this at $250 billion when all is told ($8 billion here, $1.1 billion there, etc.) but, as you can see, numbers are deceiving because the totals are so big. I encourage you to keep perspective.

The good news is that the possible $150-$250 billion is spread amongst many institutions rather than just one (like Long-Term Capital back in 1998) and the total is only 1.5% to maybe 2.5% of the total mortgage market. That is not far from historical averages.

It is still bad because real people are losing their real homes and also because of the psychological effects (the fear/greed syndrome), but the reality is not beyond reason.

Pay off your mortgage - another reason

I have always thought that paying off the mortgage was a key step on the road to retirement. Yet more and more seniors are quitting the work force with their mortgage still outstanding.
In theory, if you have enough pension, Social Security and investment income to service your mortgage, there's nothing wrong with carrying that debt into retirement. In practice, making those mortgage payments will likely crimp your retirement lifestyle -- and leave you in a nasty tax trap.
What trap? To pay the mortgage company, you will probably have to make larger retirement-account withdrawals, which will be taxable. This extra income could, in turn, trigger taxes on your Social Security benefit.
To be sure, this double tax whammy will be partly offset by the mortgage-interest tax deduction. But if you are near the end of your mortgage, your monthly payment may include relatively little mortgage interest, so the tax benefit will be modest.
In fact, your itemized deductions may be barely above your standard deduction.

Mortgage thoughts

INTEREST on a mortgage = Rent paid to banker instead of a landlord. Your house is not an investment! If even considered one, it is highly unlikely to be your best investment since the average return on your personal residence is about 1.1% per year average.

Oh yes, you watched prices sky-rocket from 2001-2005 but that period is over and don't forget the total cost of your investment. Interest costs to borrow the money (which are always higher than another cost), that's right, inflation; real estate taxes; commissions to buy and sell; maintenance costs and closing costs are just a few that all must be subtracted to determine your "real-inflation-adjusted" return rate. When you do, the answer over the past 25-30 years averages to 1.1%. Stocks average about 6% for a real-return (inflation-adjusted), bonds about 1.5% and, of-course, cash rarely keeps up with inflation.