Reverse mortgages have become increasingly popular in recent years, as cash-strapped seniors seek ways to keep pace with rising expenses -- not to mention cope with the pummeling their retirement savings took during the Great Recession.
(Reverse mortgages allow homeowners age 62 or older to borrow against their home equity and needn't be repaid until they move out permanently, sell the property or die.)
But the Department of Housing and Urban Development (HUD), whose Federal Housing Administration (FHA) finances the vast majority of reverse mortgages, noticed that borrowers increasingly have been opting to withdraw most or all of their home equity at closing, leaving little or nothing for future needs. Consequently, by mid-2012 nearly 10 percent of reverse mortgage holders were in default and at risk of foreclosure because they couldn't pay their taxes and insurance.
That's why last year Congress authorized HUD to tighten several FHA reverse mortgage requirements in order to: encourage homeowners to tap their equity more slowly; better ensure that borrowers can afford their loan's fees and other financial obligations; and strengthen the mortgage insurance fund from which loans are drawn.
Here's a roundup of the key changes:
First-year limit. Most reverse mortgage borrowers can now withdraw no more than 60 percent of their total loan during the first year. Under previous rules, borrowers could tap the entire amount on day one -- a recipe for future financial disaster for those with limited means.
The first-year limit may be waived for certain homeowners whose "mandatory obligations" (e.g., upfront insurance premiums, loan origination fees, delinquent federal debt, etc.) exceed the 60 percent amount; but they'll have to pay a higher upfront mortgage insurance premium -- 2.5 percent of the home's appraised value instead of the normal 0.5 percent.
In either case, the annual mortgage insurance premium borrowers must pay remains at 1.25 percent of the outstanding loan balance. (Note: Credit card debt is not considered a mandatory obligation, so those with significant credit card debt may not be able to withdraw enough to pay off their debt.)
Payout options. Generally, borrowers can take the money either as a lump sum at closing (under a fixed-rate loan), or as an ongoing line of credit or monthly payments (using an adjustable rate loan). However, lump-sum payments are now subject to the 60 percent mandatory obligations test, so if you want to withdraw more than that, you'll have to go the line-of-credit route, at least for the first year; after that, you can tap the remaining balance if you wish.
Financial assessment. Under previous rules, almost anyone with sizeable home equity could take out a reverse mortgage. Now, potential borrowers must undergo a detailed financial assessment to ensure they'll be able to meet future tax and insurance obligations.
Lenders are required to review the potential borrower's credit history. They also must analyze all income from earnings, pensions, IRAs, 401(k) plans or Social Security, and weigh it against the borrower's likely living expenses, including other outstanding debts. Those who come up short (i.e., are more likely to default) may be required to set aside money from their reverse mortgage to cover future obligations -- thereby lowering the amount of equity they'd be able to tap.
Maximum loan amounts. The new regulations also reduce the maximum amount of home equity that can be borrowed against -- 10 to 15 percent less than before, on average. Generally, the older you are, the more equity you have and the lower the interest rate, the more you'll be able to borrow. Note: The age component of this calculation is based on the youngest party listed on the loan.
Because reverse mortgages are so complicated, potential borrowers are required to consult an HUD-approved counselor before being allowed to apply. Before even getting to that stage, do your research. Helpful sites include those sponsored by HUD, the Consumer Financial Protection Bureau and AARP.A few last tips:
- Get a second opinion from an accountant, financial planner or lawyer specializing in elder law to make sure a reverse mortgage is right for you.
- Consider other options like refinancing, downsizing, tapping other assets, loans from family members, etc.
- If you do decide to pursue a reverse mortgage, shop around. Interest rates, fees and other costs vary widely by lender.
- Only use the money for essential living expenses, not for investments -- you don't want to gamble with your biggest asset.
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.
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