Get smart with your money
The millions of Americans who haven’t saved enough money for retirement still have a potential safety net: their home equity. But recent changes to reverse mortgages mean seniors and their families may have tougher decisions to make.
In my latest for the Associated Press, the changes to reverse mortgages that are causing people to think twice.
Dear Liz: I have been making interest-only payments on a home equity line of credit but starting in January the payments will increase to include principle. I would like to do a cash-out refinance of my first mortgage (I owe about $190,000) to pay off the HELOC (on which I owe $140,000).
My home is worth about $600,000, but my debt-to-income ratio is very high, and I’ve been told I won’t be approved.
I have never been late on my mortgage or credit cards, on which I owe about $30,000. I am working very hard on paying off my debt but my income is low, $25,000 a year.
I am 72, a widow and find it hard to land a good paying job like I used to have. I have to settle for what I can get.
My son and his family live with me and pay $900 rent and half of utilities but those payments are not reflected on my taxes.
The advice I am getting so far is to get a reverse mortgage for about a year, to not take any money from it and instead pay down my credit, then after a year try to refinance again. What are your thoughts on reverse mortgages?
Answer: Reverse mortgages have gotten safer and less expensive but they aren’t a good short-term solution for anyone. All mortgages have costs, and it makes little sense to pay to set up a reverse mortgage if you plan to get rid of it a few months later.
Reverse mortgages, for those who don’t know, allow borrowers 62 or over to tap their home equity to get a lump sum, a series of monthly checks or a line of credit. Borrowers don’t have to make payments on these loans, but any debt incurred on a reverse mortgage grows over time and must be paid off when the borrower sells, moves out or dies.
The most common reverse mortgage is the Home Equity Conversion Mortgage, which is insured by the federal government. The HECM loan typically includes upfront and annual mortgage insurance premiums, third party charges, origination fees, interest and servicing fees.
The amount you can borrow is based on your age, prevailing interest rates and the value of your home (the maximum home value considered is $636,150). You’ll find a calculator at www.reversemortgage.org/About/Reverse-Mortgage-Calculator that can help you estimate what you can borrow and the costs.
Normally, people can’t access more than 60% of the borrowed amount in the first year. That’s to prevent them from running through all their equity in a short time. The exception is when the money’s being used to pay off existing loans. You probably would be able to borrow just enough to pay off your current mortgages, but the upfront mortgage insurance premium you would owe would be high: 2.5%, rather than the usual 0.5%.
Another complication is the fact that you have family living with you. You’d need to think through what would happen if you died, had to sell or moved into a nursing home, because that could leave your son and his family homeless if they weren’t able to pay off the mortgage.
A final concern is the fact that you’ve been living beyond your means for quite a while, as shown by the amount of debt you have. Eliminating mortgage payments could help you pay off your remaining debt, but that’s only if you keep your expenses in line with your current income — not what you were able to spend when you had a good job. There’s also no telling how much longer you’ll be able to continue working, which would mean getting by on even less.
Consider meeting with both a nonprofit credit counselor and a bankruptcy attorney to understand your options. You can get referrals from the National Foundation for Credit Counseling (www.nfcc.org) and the National Assn. of Consumer Bankruptcy Attorneys (www.nacba.org), respectively.
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Many financial planners view reverse mortgages as a last resort—expensive and unwise except for those who have no other options.
Recent research and changes in the federal reverse mortgage program are starting to change those views, planner Michael Kitces told a group at the AICPA Advanced Financial Planning Conference in Las Vegas last week.
It turns out that reverse mortgages don’t work that well as a last resort. They’re often much better employed earlier in a client’s financial life. And even people who don’t need to supplement their income by tapping their home equity might want to consider setting up a reverse mortgage line of credit.
This thinking is so at odds with what had been conventional wisdom that I’m glad Kitces was the one leading this particular seminar. Kitces is a bright light of the financial planning community, one whose research and scholarship have changed others’ thinking about complex financial topics. (He blogs at Nerd’s Eye View, in case you want to check out his posts for planners.)
Reverse mortgages allow people to tap some of the equity in their homes without having to repay the loan until they leave those homes—either by selling, moving out (such as into a nursing home) or dying.
Payouts can take three forms: a lump sum, a stream of monthly payments that can last a lifetime, or a line of credit borrowers can tap when they want. The lump sum option can come with a fixed rate; otherwise, the loans are variable. Interest charged on the amount borrowed means the debt grows over time—but again, no payments are due until the borrower leaves the house.
Borrowers typically can tap 40% to 60% of their home’s value up to a cap in value of $625,500.
Although people can apply for such loans as early as age 62, planners traditionally warned people to put it off as long as possible. The concern was that borrowers would run through their home equity quickly and then face years or even decades with no other resources.
But research found that people who delayed often couldn’t get enough out of reverse mortgages to help their situations, Kitces said. People who applied earlier, and used the loans to take pressure off their portfolios, did better.
Having the reverse mortgage allowed them to pull less out of their savings, increasing the odds their savings would last, research found. Borrowers could take a strategic approach using a line of credit: tapping it during bad markets, to allow their investments time to recover, and paying back the line during good times.
Reverse mortgage lines of credit have another interesting feature: the amount you can borrow grows over time. Borrowers who apply for a credit line early and leave it untouched could wind up being able to tap 80% or more of their home equity.
The Wall Street Journal summarizes the new thinking in this post. You can read some of the research published in the Journal of Financial Planning here and here.