Yahoo Finance: Reverse Mortgages Not Only for the Desperate

As Baby Boomers move into retirement, being able to remove the burden of a mortgage payment can be a tremendous help. Though reverse mortgages have had a less than stellar reputation over the years, they can be a useful financial tool for the right homeowner and the right situation, according to a recent article from Yahoo Finance.

Reverse mortgages are not only useful as a last resort option, the article points out. “Years past, financial planners didn’t view reverse mortgages as a planning tool,” David Johnson, associate professor of finance at the Maryville University in St. Louis, says in the article. “It was viewed as a last resort, and they assumed that the only people that do reverse mortgages are people that desperate. Clearly that’s not the case, and I think they are starting to view differently now.”

The payment methods available for reverse mortgages are also important to understand. Choosing between monthly payments, a lump-sum payment or a line of credit are all explained in the article.

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Many homeowners like having the line of credit available, especially if they don’t need the money right now, Beth Paterson, executive vice president of the Reverse Mortgages SIDAC in St. Paul, Minn. explains in the article.

How reverse mortgages affect adult children is always something potential borrowers are concerned about. But, in many cases, adult children won’t be too heartbroken about losing the inheritance, they will be happy their parent is financially secure, the article points out.

Another criticism of the reverse mortgage product is that they are too expensive, however, the article notes that the costs for a reverse mortgage are no different from a conventional mortgage.

“It’s still going to be accruing interest on the house the same way as a conventional mortgage,” Peter Bell, president and CEO of the National Reverse Mortgage Lenders Association, says in the article “The question is whether you are going to be making those months payments now or let that be paid off later.”

There are so many facets to the reverse mortgage product and making sure borrowers understand them all before signing anything is vital to the program’s success.

Read the full article on Yahoo Finance.

Written by Alana Stramowski

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  • Here is a clear example of a lack of mastery of the subject matter: “They already have this debt on the house, so instead of making their mortgage payments, they are just paying it out of their equity before they leave the home,” she says. Equity when used in the context of a finance subtraction problem means the fair market value of the home minus the liens against it.

    So what happens if the value of the home goes below the current balance due on the existing debt? How is it that current equity will pay for anything? But I am giving the person being quoted the benefit of the doubt. However, if the value of the home rises, it is not just today’s equity that will be at risk; it is the entire value of the home. The risk with a reverse mortgage is never today’s equity; it is always about the value of the home at the time of termination.

    Here again is another interesting use of the word equity: “Because the homeowner isn’t making monthly payments to cover upfront costs, interest and mortgage insurance, the equity on the house can quickly shrink as the loan balance gets bigger over time.” Equity can shrink from loss in home value as well. If home value grows faster than the rate that the loan is growing at, equity will grow.

    Yet the very most important aspect of a reverse mortgage was glossed over. A reverse mortgage is first and foremost a nonrecourse mortgage. Clothing this product in terms surrounding equity takes away the impact of debt. This debt is no different than any other negatively amortizing mortgage but it is also nonrecourse meaning that the most the borrower will be required to pay is the title to their home. If the value of the home is insufficient to pay off the debt, the nonrecourse nature of the note will mean the lender cannot obtain a deficiency judgment against the homeowner as long as the homeowner has abided by all of mortgage covenants.

  • Recently I looked at some projections on the termination costs of HECMs. The results were both surprising and a little unsettling.

    For example, say a borrower takes 50% of the principal limit at closing and the remainder at the end of the third year. Say the average effective interest rate is 5.5% and that the expected interest rate is also 5.5% on this adjustable rate HECM. Say the principal limit is $180,000 and the upfront costs were $8,500. The borrower makes no payments and the HECM terminates 30 years after closing.

    So how much did it did those finance those upfront costs grow to after 30 years? $64,033. The total balance due would be $1,355,984. Of that $214.046 is accrued ongoing MIP, $941,799 is accrued interest, and $200,139 is borrowed principal. So the accrued ongoing MIP in this very conservative example grows to more than the borrowed principal on the loan.

    What would happen to that same HECM in a rising interest rate environment, where the average effective interest rate reaches 8.2% but all of the other data is the same as the illustration above. The upfront finance costs of $8,500 would leap to $143,160. The total amount due jumps to $3,031,620. Of that accrued ongoing MIP accelerates to $373,314, while accrued interest is now $2,448,939. Of this based on borrowed principal of just $209,367. It is amazing to see financed upfront costs explode to over 16 times its original cost.

    If the average effective interest rate on the same loan was 10.75%, the balance due at the end of 30 years would be $6,470,935. Now the financed costs grow to be $305,572.

    While many of us will no longer be here in 30 years, real estate economists are talking about entering a new 60 year period of rising mortgage rates. Could mortgage rates once again reach 17% (or more)? While that seemed all but forgotten a few months ago, not long ago an attorney raised that issue when he created a HECM case study covering the years 1973 to 2002.

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