mortgages offer older homeowners a little-known way to tap their equity
Wouldn't it be nice if the mortgage
lender paid you for a change?
For borrowers 62 and older, that's
increasingly becoming an option. Reverse mortgages allow older consumers
to turn built-up home equity into cash without selling their homes.
They haven't gained widespread acceptance because reverse mortgages
are confusing -- and many of their potential customers were brought
up to think that owning a house "free and clear" should be a home
buyer's ultimate goal.
But with Americans living longer and the oldest
baby boomers nearing 60, more people soon will need a way to pay
bills and cover other retirement expenses without driving themselves
into bankruptcy. And in a surprising alliance, both lenders and
consumer advocates say those who take out reverse mortgages are
really on to something.
Special type of loan
"Simply put, a reverse mortgage is a special type of loan that
allows a senior homeowner to convert the equity in their home into
cash that they can use for any purpose that they want," says Glenn
Petherick, a spokesman for the National
Reverse Mortgage Lenders Association in Washington. "There's
no payments made by the borrower during the life of the loan and
the loan becomes repayable either when the borrower dies, if they
sell the house or if they move out of their homes permanently, such
as to a nursing home.
"But I think the main problem has been and still
is trying to get widespread consumer recognition of the products
and the benefits," he adds. "People will have to be proud that they
took out reverse mortgages and made a smart decision."
Getting borrowers to that point has proven to
be no small feat for lenders, government agencies, housing counselors
and others, despite the fact they've been trying since the late
1970s. Back then, industry officials worked feverishly to develop
the reverse mortgage concept because of the economy's condition,
according to Ken Scholen, a program specialist with the American
Association of Retired Persons.
He recalls how inflation was soaring in those
days, driving the cost of goods and services higher. That reduced
the purchasing power of cash and seniors' pensions, which in many
cases weren't tied to the inflation rate. Though home values were
shooting up at the same time, seniors had a hard time tapping into
that rising equity. Home equity loans, or second mortgages as they
were called then, weren't as prevalent and cheap as they are today.
And selling a house altogether meant giving up property that in
many cases had been in a family for more than a generation.
Reverse mortgages to
Experts hoped reverse mortgages would solve the problem. The
loans work by gradually converting home equity into cash that borrowers
can use for whatever they like.
How? Most start with a risk judgment on the
part of the lender. Reverse mortgage companies analyze a borrower's
age and the value of the home in question, as well as interest rates
at the time of application.
In general, older homeowners can borrow more
equity than younger ones. The amount has to be within limits set
by the Department
of Housing and Urban Development, the secondary marketing company
Mae or Financial
Freedom Senior Funding Corp. of Irvine, Calif. They are the
only three organizations offering reverse mortgage programs today
through affiliated lenders, banks or their own loan officers.
Depending on the plan they choose, consumers
can receive their money on either a line of credit basis, where
they draw down cash whenever they need it, or in scheduled installments.
With each withdrawal, the mortgage balance increases, just as it
shrinks with each payment on a forward mortgage. The money received
is not considered taxable, experts say.
How lenders recoup
For their part, lenders recoup principal, plus interest, in
one of several ways. If a borrower cashes out the entire balance
of available equity and then dies or moves out, for example, the
lender can obtain and sell the property. If the amount withdrawn
turns out to be less than the full market value of the home, the
house can be sold, the balance paid off and the remaining equity
returned as cash to the borrower or surviving heirs. Finally, if
the heirs want to hold on to the property, they can pay the mortgage
off with their own money.
At the end of the loan term, either the borrower
or the estate should be able to deduct the interest portion of the
mortgage balance from their taxes. Experts suggest consulting a
tax adviser on that point.
With HUD loans, which are offered through the
agency's Federal Housing Administration arm, it's possible for borrowers
to take out more money than the home is worth. That's because HUD
gradually increases the size of borrowers' lines of credit as they
age. A homeowner who lives longer than average can keep taking money
out, ending up borrowing more than the home's value.
If that happens, though, neither the borrower
nor the heirs is responsible for the excess. Borrowers pay a little
money upfront into an insurance fund to cover that possibility.
Reverse mortgages can be used for virtually
anything, but most seniors put the money toward home repairs, medical
bills and other large expenses. In some cases, the money just helps
supplement other income. With the Fannie Mae program, however, borrowers
can even buy a house under a new option made available last year.
Say a senior citizen wants to buy a $115,000
home, but doesn't want to liquidate all available assets. By putting
down $67,000, that customer creates an instant $67,000 in equity.
In the same all-in-one transaction, the person can use that equity
as a basis for qualifying on a Home Keeper mortgage, and hand $48,000
of that loan over to the seller. If all this sounds confusing, that's
because it is. Lenders have to go to great lengths to explain the
products to potential borrowers and, even then, some don't like
what they hear. As a result, reverse mortgages haven't become that
First introduced in
HUD first introduced its Home Equity Conversion Mortgage in
November 1989 and Fannie Mae rolled out its Home Keeper loan in
November 1995. But Fannie Mae, which buys both types of loans from
lenders after they make them, says it now holds just 27,000 HECM
and Home Keeper mortgages in its portfolio. Financial Freedom won't
say how many loans it has done since its entrance into the marketplace
in 1993, but senior vice president Jim Mahoney indicated the company
has loaned money against about $175 million worth of home value.
Assuming each house was worth $150,000, that's only equivalent to
about 1,150 mortgages.
"You have certain segments of the market that
don't see a need for it," says Liz Scholz, director of Fannie Mae's
senior products group. "Some don't want to leverage their home in
any way, shape or form. I think that there's another segment of
the market that just isn't aware of the products or may not understand
the product. I think there's another segment that very much wants
to keep the equity for their heirs."
In part because of that reluctance, many of
the companies that got into the business earlier this decade have
dropped out. Others have been unwilling to lend money now on the
expectation of a future payoff that may or may not come. As a result,
it's unlikely for the time being that there will be many more loan
choices for seniors than the three available now. Still, that could
change if the industry gets its way and a secondary market for reverse
mortgages develops the same way one has for regular home loans.
Such a development would allow companies to get at least some money
upfront for each mortgage they made.
"In the future we might have more variations
of it, but currently you have FHA and Fannie Mae, which are basically
the national programs," says Roger Reynolds, national reverse mortgage
coordinator for Wells
Fargo & Co.'s Norwest Mortgage division.
Nevertheless, reverse mortgages compare favorably
to other methods of financing retirement. As more people learn about
them, observers say they think more people are getting them, too.
Norwest, for one, has seen its loan volume grow by about 15 percent
to 20 percent annually in recent years.
"Reverse mortgages are just so different from
what people are used to," says the AARP's Scholen. "But you look
into the history of any truly innovative product and you see how
long it took to gain acceptance. Instant coffee, the zipper or any
number of things that we think now, 'So what's the big deal?' took
a long time to get public acceptance. And before you have acceptance,
people have to understand what it is and try it out."