A common critique of the reverse mortgage product category is that the upfront costs are too prohibitive for many people who are in need of additional cash in retirement, which leads some advisors to describe them as “loans of last resort” when no other options remain. However, after considering all of the associated costs, they can be considered a “loan of first resort” when compared with other, more popular options that exist for creating cash flow. This is according to Harlan Accola, national reverse mortgage director at Fairway Independent Mortgage Corporation in a column at Nasdaq.com.
“When all costs are considered, reverse mortgages become the loan of first resort,” Accola writes. “The fact is that they actually cost considerably less when used as a source of income as compared to a portfolio or continuing to make payments from a portfolio once past the age of 62.”
Beyond the idea that cost on its own “should never be the sole issue in making any decision for an investment or purchase,” Accola says, the true metric that must be considered is one of value. By that metric, looking at some of the ways a reverse mortgage can be utilized by a senior makes a value proposition clearer, he explains. The culprit in the perception of reverse mortgages as expensive loans comes down to the mortgage insurance premium (MIP), paid to the Federal Housing Administration (FHA) at 2% of the home’s value.
“Mortgage insurance on a forward mortgage encourages the lender to lend to a borrower with a lower credit score or a small down payment so they are insured by the mortgage insurance company if there is a default,” Accola writes. “Reverse MIP is much more powerful than forward private mortgage insurance (PMI). It not only insures the lender, but also the borrower AND the borrower’s heirs. The reverse is a non-recourse loan that requires no payments until the borrower turns 150 or moves out of the house permanently. That is a rather generous guarantee and a considerable risk for the fund.”
This is where the non-recourse feature can become very useful, since the value of a home can be difficult to predict further on into the future. If a senior reverse mortgage borrower passed away in a volatile housing year like 2009, as Accola proposes, the insurance pays the difference between the amount of money owed and the reduced value of the home.
There is additional value for a person considered wealthy in using a reverse mortgage, Accola says, because as a source of cash flow, a reverse mortgage can provide a cheaper way to gain access to additional cash when compared with other options like investments.
“It also allows an advisor to keep his/her senior client fully invested in longer term risk portfolios because the cash reserve is in the reverse mortgage line of credit,” Accola says. “It eliminates the need for a cash reserve in the investment account that serves as a big drag on returns. That line of credit – unlike a traditional line of credit which has cheaper closing costs – is guaranteed never to be canceled or closed as long as the borrower pays HOI and real estate taxes.”
Read the column at Nasdaq.