Heads up, advisors: get ready to field more questions from clients about the pros and cons of reverse mortgages.
With the U.S. population aging and more boomers turning to reverse mortgages to fund their retirement, the U.S. Department of Housing and Urban Development has announced major changes to its Home Equity Conversion Mortgage program. The changes, most of which became effective on Sept. 30, are designed to prevent borrowers from tapping into the entire value locked into their homes. Specifically, new limits have been placed on the amount that borrowers can take out during the first year.
The product is touted as a safe way to finance a retirement or pay down debt, but the CFA Institute warns that prior to the new rules, seniors were taking out these loans, spending the funds, then defaulting on their mortgages when they became unable to pay property taxes and homeowner’s insurance.
Under the new rules, intended to remedy that problem, 60% is the most money a borrower can receive in the first 12 months after closing.
CFA Institute: New Rules Protect Consumers
HUD changed the rule not only to cut down on borrowing but to bring more transparency to the product and to protect consumers, said Bob Stammers, a chartered financial analyst and director of Investor Education at CFA Institute, in a phone interview on Tuesday. Reverse mortgages are increasingly promoted by lenders for baby boomers 62 and older who are house-rich but cash-poor.
“Reverse mortgages are often misunderstood by the seniors,” Stammers said. “The biggest change is that the program will be seen less as an emergency fund and more as a tool to allow seniors to use the reverse mortgage as a retirement fund over time. There’s a penalty for taking out a large portion of the loan upfront, and that’s on purpose, to encourage use of reverse mortgages as a financing tool in retirement rather than a funding source of last resort.”
In announcing the HECM program changes, Federal Housing Commissioner Carol Galante pointed to the problem of younger borrowers with more debt and stagnant home prices having contributed to the program’s added risk. “Our goal here is to make certain our reverse mortgage program is a financially sustainable option for seniors that will allow them to age in place in their own homes,” Galante said in a statement.
Mandatory counseling by HUD-appointed counselors is a must, said Stammers, who also urged borrowers to seek help from their financial advisors before applying for a reverse mortgage.
Using Reverse Mortgages as an Estate Planning Tool
Estate planners may want to consider reverse mortgages as a risk management tool, Stammers said. If a planner thinks a home is highly valued but doesn’t expect a lot of appreciation, “you get a lot of money upfront, and the bank takes the risk,” he said.
“Or, if the home is undervalued, and you can’t sell the house now, then take out the reverse mortgage and wait for it to appreciate,” Stammers said. “That’s an estate planning tool that families can use, although reverse mortgages have a large prepayment penalty in the first three years. But if the housing market is doing well and you think there’s not much appreciation left, that’s a great time to do a reverse mortgage, because you’re putting the risk of the loan on the lender.”
Because of the current low-interest rate environment, a lot of borrowers are turning now to reverse mortgages, and if a family does go with a reverse mortgage for an aging relative, when the borrower dies and the estate pays for loan, the government has to pay for the loss position, Stammers said.
“This is a great benefit of the loan because you or your estate will never be in a loss position when the borrower vacates the home,” he said. “Another benefit is that the cash coming from the home is tax-free. But be aware that there won’t be a lot of equity when you leave. The home isn’t something you’re likely to pass on in your estate.”
According to the National Reverse Mortgage Lenders Association’s summary of the HECM changes, HUD revised its rules because, since the 2009 housing crisis, the HECM program has experienced major demographic and behavioral shifts that have increased the risk of losses to the program. In announcing the changes, HUD officials said, “these critical program changes will realign the HECM program with its original intent, and thereby aid in the restoration of the Mutual Mortgage Insurance Fund and help ensure the continued availability of this important program.”
The association lists these major changes to the HECM program:
- A restriction on the amount of funds that can be disbursed at closing or during the initial 12 months after closing
- A mandatory financial assessment for every prospective borrower
- Establishment of set-aside accounts to pay mandatory property charges, such as property taxes and homeowners insurance, for borrowers who pose a future risk of defaulting on their reverse mortgages
- Adoption of a single disbursement lump sum option
- Institution of a new upfront mortgage insurance premium structure
- Elimination of the HECM Standard and Saver programs
- Changes to the Principal Limit Factor (PLF) tables that determine how much money a borrower is eligible to receive
Read Reverse Mortgages and Retirement Planning: Bridging the Income Gap by Thomas Jefferson School of Law professors Robert Bloink and William Byrnes at ThinkAdvisor.