Reverse mortgages have long provided a tool for clients over age 62 to supplement their available retirement income while remaining in their homes. The option can be attractive to a wide range of clients, including higher income clients who see the strategy as a means of generating retirement income without triggering Medicare surcharges—often by establishing a reverse mortgage as a line of credit for future use.
Despite this, many seniors may now find a reverse mortgage line of credit substantially less attractive—the Department of Housing and Urban Development (HUD) has recently implemented new rules that could change the game for many clients who may have planned on tapping their home equity in the future.
Reverse Mortgage Basics
A reverse mortgage is essentially a tax-free loan that allows a client to draw upon the equity in their home. Importantly, these funds are not counted in determining a client’s MAGI, making the reverse mortgage option attractive to many because it provides income without increasing the client’s income for purposes of Medicare’s income-based surcharge. For other clients, the reverse mortgage may simply be a means of generating retirement income to meet expenses without having to move.
The option—also known as a home equity conversion mortgage (HECM)—is only available to homeowners who are at least 62 years old. The client must either own the home outright or must have a mortgage balance that is low enough so that it can be paid off with the reverse mortgage funds. While interest is charged on the loan, no repayments are due until the client dies or moves out of the home. If the house is sold, the proceeds must be used to pay off the reverse mortgage.
The value of the loan depends upon the overall value of the home, the client’s age, interest rates and upfront costs associated with securing the reverse mortgage. Generally, the reverse mortgage may be available as a line of credit, through monthly payments or as a lump sum.
New HUD Rules on Reverse Mortgages
The impact of the new rules, which took effect October 2, varies based upon whether the client immediately takes out a lump sum or simply establishes the reverse mortgage as a line of credit that he or she can draw upon in the future if necessary.
Clients who take out a reverse mortgage pay an upfront mortgage insurance premium to a federal housing administration (FHA) approved lender before they can gain access to the funds. Generally, for borrowers who access less than 60 percent of their available loan proceeds up front, this fee has been 0.5 percent. Under the new rules, the initial fee will increase to 2 percent of the maximum loan amount.
For borrowers who access more than 60 percent of the loan proceeds upfront, the initial fee will actually decrease from 2.5 percent to 2.0 percent. While leveling the playing field with respect to the upfront reverse mortgage fee might encourage borrowers who choose the lump sum option to take a larger initial loan, the line of credit option becomes less attractive under the new rules because of the higher upfront cost for these borrowers.
The annual premium amounts that borrowers are responsible for also decrease from 1.25 percent to 0.5 percent of the outstanding loan balance under the new rules. Lower annual costs generally mean that the reverse mortgage line of credit will grow more slowly—a potential negative factor for those who choose that option—but also that the loan itself will grow more slowly, so that clients who choose the lump sum option will save over time.
The new rules also modify the “principal limit factors” that impact the amount the client will actually be able to borrow through a reverse mortgage. The currently existing interest rate floor is reduced from 5 percent to 3 percent, and the principal limit factor tables used in determining the loan amount have also been reduced. While this change is expected to potentially reduce the available amount for line of credit borrowers, it may lower the cost for those who borrow larger amounts (again, by slowing both the line of credit growth and the loan amount).
The new HUD reverse mortgage rules only impact clients seeking to establish a reverse mortgage after October 2, 2017—as a result, clients must now factor the changes into the equation in determining whether a reverse mortgage strategy remains attractive.
For previous coverage of reverse mortgages in Advisor’s Journal.
For in-depth analysis of reverse mortgages and Medicaid, see Advisor’s Main Library.