Something Had to Change
Reverse mortgages are a popular way for seniors to access needed funds. In a reverse mortgage, you are, in essence, incrementally selling your home back to a lender with the proceeds set up as a line of credit. You can use that line of credit right away, or you can allow that credit to ride for more challenging times down the road.
The Department of Housing and Urban Development (HUD) backs reverse mortgages through the Home Equity Conversion Mortgage (HECM) program. Thanks to the HECM program, you can never owe more on your reverse mortgage than your home is worth. In addition, as long as you meet loan obligations such as paying property taxes and properly maintaining your home, you can defer payments on the reverse mortgage until you die or move out.
Those are great features for senior consumers – but terrible ones for insurers. Tack on a rise in foreclosures and interest rate concerns that raise volatility, and the HECM program becomes a money-losing proposition for the government (and therefore, eventually, for taxpayers).
HUD officials recently noted that the HECM program represented a $7.7 billion liability as of 2016, and it threatens to drag down the entire FHA insurance fund that covers all single-family loans – traditional mortgages included. At this point, HUD projects that every reverse-mortgage loan will lose money. The total liability could reach $12.5 billion by 2023, according to a 2016 HUD actuarial report.
Clearly, HUD had to make changes, and they have done so. As of Monday, October 2, those changes will take effect – but how will they affect you as a potential candidate for a reverse mortgage?
More Up Front, Less Overall
HUD made two major changes to the HECM program – greater front-loading of insurance costs and lower limits on the total amount that seniors can borrow.
The mortgage insurance premium (MIP) on a reverse mortgage contains a single upfront component along with an annual premium. Prior to October 2, the upfront MIP could range anywhere from 0.5% to 2.5% depending on disbursements. After October 2, the upfront MIP is a flat 2% fee on all reverse mortgages. To offset the collective cost to borrowers, the corresponding annual insurance rate dropped from 1.25% to 0.5%.
By bringing in more of the loan costs upfront, HUD can simultaneously reduce overall risk and improve short-term cash flow. From your point of view as a consumer, this could raise the threshold values at which a reverse mortgage makes economic sense for you.
The overall borrowing limits, which are a function of a borrower's age and current interest rates, have been scaled back. The Washington Post and the New England Center for Investigative Reporting (NECIR) note that under the old rules, a 62-year-old with a loan interest rate of 5% could borrow up to 52% of their home equity, but the new rules will cut that limit to 41%. Similarly, an 82-year-old borrower at the same rate could borrow 60% by the old rules but only 51% by the new rules.
For many borrowers, this will probably be an acceptable tradeoff. It depends on the reasoning for the reverse mortgage. Younger borrowers or those who are trying to squeeze every bit of equity possible from their home may find this new cap to be a great disadvantage. The caps may not affect borrowers with more limited and targeted goals like switching a certain percentage of home equity into alternate investments.
Critics such as Ira Rheingold of the National Association of Consumer Advocates claim that HUD is making low-income homeowners pay for problems rooted in program mismanagement – for example, guiding homeowners toward larger loans through removing younger spouses from the loan documents, effectively isolating them and exposing them to foreclosures upon the borrower's death. Such practices increase risk – the very issue HUD is trying to mitigate.
In any case, the rules have now taken effect. It's up to you to decide whether HUD's effort at stabilizing the HECM program drives you to alternate financial options.
The HECM program changes will change the cost-benefit calculations, but it's still the larger-scale factors that will determine whether a reverse mortgage is right for you. What is your reason for considering a reverse mortgage in the first place? Are you using your equity toward retirement funds or alternative investments? Is it a safety cushion in case the market wipes out your 401(k) close to retirement age? Do you simply want your equity converted to cash because you have no heirs to accept your home after your death?
HUD is not adopting these changes to help or hurt homeowners – they're adopting the changes to try to stay solvent over the long run. Like any other insurer (which HUD is in this case), they are trying to retain benefits while limiting risk.
That should also be your guiding philosophy as a homeowner attempting to decide whether a reverse mortgage is right for you. Is a reverse mortgage a good deal for you compared to alternative paths of achieving the same financial goal? At least consider your options before leaping directly into a reverse mortgage, and do your research to understand fully the risks involved before proceeding.
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