Reverse Mortgage — Part 2 of 3
Posted on June 1, 2016 by bob in Financial, MoneyWise, NewsUCanUse
While Home Equity Conversion Mortgages (HECMs), or FHA-insured reverse mortgages, may be a helpful tool, their unwise use has caused serious difficulty for more than one family.
HECMs have been around for years, and the rules associated with them have changed frequently, making it difficult even to find out what the current rules are. Anyone considering an HECM should carefully investigate the rules and evaluate possible adverse outcomes before using one. Required HECM counseling by a HUD-approved advisor helps address this issue.
One past problem occurred when a couple desired to use a reverse mortgage and one spouse was under age 62. Some younger spouses transferred their home ownership to the older spouse, who then applied individually for the HECM. If the older spouse died first or vacated the house for health reasons (e.g., moved into a nursing home) for 12 consecutive months, the HECM became due and payable and the younger non-borrowing spouse faced eviction. While the rules now frequently allow the younger spouse to remain in the home when the older spouse dies, couples where one spouse is under 62 should clearly understand their impact before using an HECM.
A second problem can arise from the requirement that the borrower pay the annual property tax and insure and maintain the home. Many people who have habitually paid property taxes and homeowners insurance as part of their mortgage payment feel it is “unfair” that they have to pay these costs when a mortgage payment no longer is required. Sometimes people have become financially unable to make those payments. In such cases, the HECM falls due and the borrowers can lose the home. To reduce this risk, lenders now must evaluate borrowers’ ability to cover such expenses before approving an HECM.
A third problem results when the borrower withdraws enough of the maximum available loan (more than 60% of the limit) in year one, triggering the 2.5% initial FHA Mortgage Insurance Premium (five times the rate charged when no more than 60% of the maximum is borrowed in year one). Since fixed rate HECMs only allow a single withdrawal at closing, borrowers who use them are more likely to incur high initial MIP charges than those who use variable-rate HECMs. While variable rate HECMs provide more flexibility, heavy up-front borrowing with them can have results similar to a big initial loan with a fixed-rate HECM.
Fourth, if the borrowers are not fairly certain the home they are in is the final one they plan to own, then using an HECM is likely inappropriate since the closing costs incurred and monthly MIP accrual will eat into the home equity, leaving less value when a change of home is desired. In such a case, a Home Equity Line of Credit (HELOC) may be a better vehicle to temporarily access part of one’s home equity.
Fifth, a borrower’s taking the maximum available loan under an HECM increases the likelihood that there will be little if any home equity remaining when the mortgage comes due—say, at the borrowers’ death or permanent absence from the home. For this reason, an HECM is usually a bad idea unless the borrower has no interest in leaving the home intact to his heirs. In such a case, any desire to provide a legacy must be addressed in some other way. In particular, a home which has been in the family for generations, and to which one’s heirs may have a strong attachment, should probably not serve as HECM collateral.
Many advisors feel that the problems associated with HECMs are not the fault of the instrument itself, but of its misuse. In any event, the best protection against problems is knowledge of the facts, understanding what could go wrong, and making a well-informed decision. Next month we’ll consider the prudent use of HECMs.
Alan Wallace
Alan Wallace, CFA, ChFC, CLU, is a Senior Private Wealth Advisor for Ronald Blue & Co.’s Montgomery office, www.ronblue.com/location-al. He can be reached at 334-270-5960, or by e-mail at alan.wallace@ronblue.com.
