The reverse mortgage can be controversial, viewed as a last-ditch effort to fund long term care, Medicare premiums and other retirement health care expenses.
While the Home Equity Conversion Mortgage (HECM) does have a checkered past, it has become a sound option for retirement planning in recent years.
Still, relatively few advisors are aware of the HECM’s improved security and benefits. With greater government protections and more rigorous qualification standards, today’s reverse mortgages can be extremely useful for paying for health care while protecting other assets and income streams. They’re not for everyone, but any advisor with retiring clients should be aware of their rules and benefits.
Cause for controversy
“For people without firsthand experience who haven’t worked with the reverse mortgage in recent years, it is somewhat of a mystery,” says Jesse Allen, Executive Vice President of Alternative Distribution at American Advisors Group.
Congress created the HECM in 1987 to help seniors whose retirement savings had fallen short. They were aggressively pitched through television and radio ads as a risk-free way to gain extra retirement income. Over the next two decades, they took off.
But when the housing bubble burst, cash-strapped homeowners fell behind on tax and insurance payments, and defaults rose from 8 to 12 percent in a 4-year timespan. As a result, more than a few seniors lost their homes.
The good news is that can all be ancient history.
Rules and improvements
“The HECMs of the last few years are exactly the opposite [of the older mortgages],” says Gary Borowiec, RICP and managing partner at Atlas Advisory Group.
In response to the housing crisis, the HUD created its guidelines for financial assessment, which took effect April 2015. Now, lenders must analyze borrowers’ incomes and credit histories to determine whether they’ll be able to cover necessary expenses, and safeguards are in place to keep people from losing their homes.
To qualify for a HECM, a homeowner must be 62 years of age or older, and the house must be their primary residence. Loan amounts are determined by the HUD’s principal limit factor tables, which take into account age, home value and interest rates.
The current loan limit is $625,000. Generally, the older the borrower and the more valuable their home, the more money they’ll be able to get.
Unlike a home equity line of credit, a HECM only requires a one-time qualification and appraisal. Since the loans are FHA-insured, “you can always buy it back at 95 percent of that initial home value, even if it’s a loss to the bank,” says Borowiec. Borrowers are assessed on their abilities to pay property taxes, homeowners insurance and maintenance costs; they never have to requalify or refinance. As long as they live in their home, the line of credit remains in place.
The credit line growth factor
Borrowers can receive their money in a lump sum, fixed monthly payments, line of credit or combination of all three. For most clients – particularly those who plan well in advance – credit offers the greatest opportunity for savings and growth.
“The unused portion of the line of credit grows at the rate of return during the entire life of the loan,” says Allen. “This is unique to the HECM, and it’s the feature that most interests clients and advisors.”
While many seniors see the HECM as a last resort only appropriate after they deplete all other assets, its growth potential actually makes it a favorable option early in retirement.
“The longer it’s unused, the more the accessible principle grows each year,” says Borowiec. “It makes sense for anyone who may use it to get it in place.”
With health care costs outpacing inflation, those additional dollars may come in handy for clients who can afford to spend down their other assets first.
Perhaps one of the HECM’s greatest health care cost benefits is its ability to maximize income and minimize risk.
“The sequence of returns is critical in the first five years of retirement, and a health crisis can severely impact it,” says Borowiec. “The HECM can provide needed income in the early years while giving clients’ other assets time to grow, even in a bear market.”
Home equity can provide a growing line of credit or guaranteed lifetime income. The HECM’s tenure option offers fixed monthly payments for the life of the loan, and even if the loan exceeds the value of the home, borrowers (or their heirs) are only on the hook for 95 percent of that value.
The HECM can also serve as a bridge to Social Security. For a person born between 1943 and 1954, delaying distribution until age 70 results in a 32 percent higher payoff than collecting at age 66 -- and 76 percent more than collecting at age 62.
“This is critical because Social Security is the best annuity you can have, and it’s hedged for inflation,” says Borowiec.
More than just an extra source of income, HECM distributions can also cover costs that long term care insurance (LTCI) and Medicaid may not. Not all LTCI policies cover in-home care in full, for instance, while HECM payouts can be used for professional or family caregivers.
Some retirees also use their loans to pay for home renovations, durable medical equipment or even more accessible, retirement-friendly homes.
Finally, the HECM can be a lifesaver when one spouse wants to stay in the home while the other receives nursing care.
“If a couple takes out a reverse mortgage, it’s not unusual that one of them would have to go into a nursing home, and it’s not a maturity event,” says Allen. “The spouse still living in the home can continue to appreciate the benefits of the reverse mortgage."
A viable option
A reverse mortgage isn’t for everyone. For clients with more than enough assets to cover health care and other retirement expenses, the benefits probably don’t outweigh the lender fees, mortgage insurance and other associated costs. It’s also not a great option for couples whose budget won’t even cover taxes or insurance.
For clients with more home than cash, however, it can be an excellent way to boost retirement income and provide greater security and quality of life than they’d otherwise be able to achieve.
“For those who haven’t taken a recent look at it, I would certainly suggest they do,” says Allen.