Consumer Concerns for Older Americans

Spending the House: A Quick Guide for Advocates on Reverse Mortgages

A reverse mortgage is a type of loan that allows senior homeowners to convert the equity in their homes into a source of income, without having to sell the home.  For many seniors, the accumulated equity in their home is their primary or only financial asset.  Such seniors are on a fixed or limited income and do not have enough money saved to pay for uninsured medical expenses, home improvement, or to meet other pressing needs.  For these financially strapped seniors, reverse mortgages are an attractive option. 

A reverse mortgage, however, must be carefully evaluated as it is more complex than most home equity loans.  A senior, for example, must not only understand complicated budget projections, but also make predictions as to his or her future financial needs.  To assist seniors with this assessment, counseling is a required part of the application process for most reverse mortgages. 

What Makes a "Reverse" Mortgage Different

Unlike a traditional mortgage, a reverse mortgage does not require immediate repayment from the often limited incomes of seniors.  The lender makes payment to the to the senior either in a lump sum, in monthly installments, or as a line-of-credit.  Depending on the reverse mortgage product, repayment of the loan is not required until the end of the loan term or when the borrower sells the home, leaves the home permanently, or dies.  The senior retains title to the home and continues to be responsible for paying the property taxes, insurance and for the general upkeep of the property.  

One important feature of a reverse mortgage is that it is a "non-recourse" loan.  This means that the lender cannot seek repayment from any source except the property that secures the loan.  This is particularly important if the property depreciates in value and the homeowner owes more than the property is worth.  

Reverse mortgages are rising-debt loans.  As cash advances are paid out to the borrower, interest accrues and is compounded, and over time the total amount owed increases significantly. Insurance and taxes are also added monthly to the balance.  The increase in debt tends to quickly deplete any equity that a senior has built up over the years.  For this reason, a reverse mortgage is usually a one-time deal that requires careful consideration and analysis of a senior homeowner’s long-term financial needs. 

Eligibility 

In order to qualify for a reverse mortgage, the homeowner must be at least 62 years old, the property must be their primary residence, and they must own the home free and clear or have a low outstanding mortgage balance or other lien which can be paid off with the loan proceeds.  There are no income or credit qualifications.  Thus, low-income seniors may qualify for this loan. 

Reverse mortgages are either FHA-insured, lender-insured, or uninsured.  FHA insurance guarantees that loan advances will continue even if the lender fails to make them.  In order to qualify for a FHA insured Home Equity Conversion Mortgage (HECM), the property must be either a single-family home, a 1-4 unit building, with one unit occupied by the borrower, a manufactured home (mobile home), or a unit in a federally approved condominium or planned unit development.   

An important requirement for obtaining a HECM is attendance at a consumer education session on reverse mortgages.  The HECM requires  borrowers to receive mortgage counseling from a HUD-approved agency.  The counseling session must include discussion of other options available to the homeowner, including other home equity conversion options; the financial implications of a reverse mortgage; the tax consequences of a reverse mortgage; the impact on eligibility for federal and state assistance programs; and the implications for the borrower’s estate and heirs.^[1]  A list of HUD-approved counseling agencies can be obtained by calling HUD at 1-888-466-3487. 

Potential borrowers should also be aware of the protection offered by the Federal Truth-in-Lending Act, which requires lenders to inform them of the terms of the reverse mortgage.^[2]  Lenders must disclose the Annual Percentage Rate (APR) and payment terms of the reverse mortgage. However, reverse mortgages are excluded from the special consumer protections for high cost mortgages contained in the Home Ownership and Equity Protection Act.^[3]  It is vital that the borrower understand the implications of the documents they are signing. 

Payment Options 

The lender provides a homeowner with cash in one of these basic payment forms.  

Lump Sum: The homeowner will receive all the cash at one time.

Tenure: Under a tenure plan the homeowner will receive monthly payments for as long as she occupies the home as her principal residence. 

Term: A term plan provides monthly payments for a fixed period of time.

Line-of-Credit: The homeowner is allowed to draw up to a maximum amount of cash at times and in amounts of her choosing as long as she occupies the home.  No interest is charged on the unused portion of the line of credit.   

The amount of money the borrower receives will depend on her age, the interest rate and the value of the home.  Generally, the older the borrower, the larger the percentage of the home’s value that can be borrowed.  

Potential Difficulties with Reverse mortgages 

• The costs of obtaining a reverse mortgage, particularly the up-front costs, can be high. Most lenders allow a portion of these up-front costs to be financed as part of the loan balance. In addition, interest, insurance and service charges will be added monthly to the balance.  Thus, the amount the senior owes the lender will increase over time.
• The proceeds of the loan may be inadequate to meet the senior’s current and future needs.  For example, a 65-year old with $50,000 in home equity who wanted a reverse mortgage as a monthly income supplement may get as little as $100 a month.^[4] 
• A reverse mortgage may have some impact on a senior homeowner’s continued eligibility for need-based government benefits programs, such as Supplemental Social Security (SSI) and Medicaid.  Reverse mortgage payments should be structured so that they are spent during the month in which they are received.  If the proceeds are retained by the borrower beyond the month in which they are received, it may be considered "income," and count toward the resource limit under these programs. 
• Senior homeowner’s may be offered the option of using some or all of a lump sum payment to purchase an annuity.  The annuity is an insurance product.  Monthly payments are made to the borrower for the rest of the borrower’s life. The IRS does not tax loan advances as income, but annuity advances may be partially taxable. 
• Reverse mortgages may be offered by unscrupulous individuals who want to take advantage of senior homeowners facing financial difficulties.  For example, some senior homeowners have been contacted by firms offering to refer them to lenders that do reverse mortgages in exchange for a "small" percentage of the loan.  This information is available for free from the Department of Housing and Urban Development (HUD) by calling toll-free, 1-888-466-3487.

Evaluating Reverse mortgages as an Option 

A CASE STUDY:  Mrs. Smith is 85 years old.  Her income is $850 per month income, and she owns her house free and clear in a rapidly gentrifying neighborhood.  The house is now valued at $125,000.  Her monthly expenses are $800, which makes it hard for her to handle any unexpected expenses.  Recently Mrs. Smith received notification from the government that due to the increased value of her home, her property taxes will increase.  Would a reverse mortgage be a viable option for Mrs. Smith? 

As the property tax is the main problem for Mrs. Smith, counselors should determine if there is a property tax abatement program available for senior homeowners.  All tax credit and abatement programs, along with any other programs which might help reduce her expenses should be explored.   

Next, a counselor would assess how much supplemental income Mrs. Smith would receive with a reverse mortgage.  On a tenure plan, Mrs. Smith’s monthly payments might be as much as $756, which would bring her total monthly income to $1,606.  On a term plan (10 years) her monthly payments could be as much as $956, bringing her total monthly income to $1,806. 

• Pros: Given Mrs. Smith’s age, and the value of her home, the increase in her monthly income is sufficient to give her a comfortable additional margin.

• Cons: Mrs. Smith should evaluate whether she may need to tap into her home’s equity in the future.  For example, she may need this source of income to pay for uninsured medical care.  If she wishes to receive that care at home, she must evaluate whether the  additional income will make her ineligible for stay in-home care.  Of course there is no guarantee that the additional funds will cover all future needs.  Also, Mrs. Smith must consider whether there are any remaining family members to whom she would like to will the property. 

It may be a close question as to what is best for Mrs. Smith, and other home equity loan options should be explored. However, if Mrs. Smith has a clear understanding of the consequences, she may be best able to determine whether her current financial strain outweigh future uncertainties. 

Conclusion

While they can be a tremendous benefit, reverse mortgages are not for everyone.  They are expensive, particularly in the short run.  Older homeowners should be encouraged to explore alternatives such as property tax credit and abatement, and eligibility for other programs.  Those who wish to leave their property to their heirs may not want to deplete their equity.  Sound, in-depth counseling on these issues is essential, and is required by the HUD program, and some state laws. 

For More Information

American Association of Retired Persons (AARP), Home Made Money: A Consumer Guide to Reverse Mortgages, call 1-800-424-3410 to order or http://www.aarp.org.  

Dept. of Housing and Urban Development (HUD), Home Equity Conversion Mortgage, Demonstration Handbook 4235.1, Publications Service Center, Room B-258, 451 7th St. S.W., Washington, D.C. 20410, (888) 466-3487, http://www.hud.gov/rvrsmort.html. 

Fannie Mae, 3900 Wisconsin Ave., N.W., Washington, DC 20016-2899, (800) 732-6643 http://www.fanniemae.com/singlefamily/l 

Federal Trade Commission, Facts for Consumers: Reverse mortgages, Office of Consumer/Business Education,  Washington, D.C. 20580, http://www.ftc.gov.  

National Center for Home Equity Conversion, 7373 147th St. NW, Apple Valley, MN 55124, (614) 953-4474, http://www.reverse.org. 

California: Victoria Wong and Norma Paz Garcia, There’s No Place Like Home: The Implications of Reverse mortgages on Seniors in California, Consumers Union, August 1999. 

Massachusetts: Financial Options for Older Homeowners: A Consumer Guide, Homeowner Options for Mass Elders (H.O.M.E.) 30 Winter Street Boston, MA 02108. 

Advocates seeking more information can also call the National Consumer Law Center at (617) 542-8010. 

This brochure was supported, in part, by a grant, number 90-AM-2041, from the Administration on Aging, Department of Health and Human Services, Washington, D.C.  20201.  Grantees undertaking projects under government sponsorship are encouraged to express freely their findings and conclusions.  Points of views or opinions do not, therefore, necessarily represent official Administration on Aging policy. 

May 2001