Reversal of Fortune

There is now an extremely important tool available to help seniors on fixed incomes maintain their standard of living and be able to remain in their homes. It is called a reverse mortgage, and there is a great deal of confusion and misinformation surrounding it. Many boards are asking, “What is it? Should we forbid it?” Here’s what a board should know.

A reverse mortgage is a type of loan available to seniors (62 and over). It is a way of converting their home equity into cash payments while letting them retain ownership of the property, live there, and avoid monthly mortgage payments. Repayment of the loan is deferred until the borrower is no longer living in the home.

In a typical mortgage, a homeowner pays a monthly, amortized amount and, after each payment, the owner has more equity in the house. After a certain amount of time (typically 30 years), the mortgage is paid in full and the property released from debt. In a reverse mortgage, the homeowner pays nothing each month and all interest on the debt is added to the lien on the property. If the owner receives monthly payments, then the debt on the house or apartment increases each month. To qualify for a reverse mortgage, the borrower must be at least 62 and pay off any existing mortgage(s) with the proceeds from the reverse mortgage. There are no minimum income or credit requirements and, for most, the money can be used for any purpose. Before borrowing, applicants must seek Department of Housing and Urban Development-approved counseling as a free safeguard for the borrower and his/her family, to make sure they completely understand a reverse mortgage and the process of obtaining one.

The amount of money that an individual homeowner can receive from a reverse mortgage depends on his/her age, the appraised value of the home by the Federal Housing Administration (FHA) or Fannie Mae (FNMA), and the starting interest rate (effective upon closing of the loan). There is also a type of reverse mortgage for homes valued over the maximum Fannie Mae limit. In a reverse mortgage, a borrower can be paid in a lump sum; in a monthly (payment of advances); through an increasing line of credit; or by a combination of all three.

The money received (i.e., the loan advances) is not taxable and does not affect Social Security or Medicare benefits. However, if the borrower receives Medicaid, Supplemental Security Income, or other public benefits, loan advances will be counted as “liquid assets” if the money is kept in an account (savings, checking, etc.) past the end of the calendar month in which it is received. The borrower could then lose eligibility for such public programs if their total liquid assets are then greater than those programs allow.

The negative aspect of the loan is the cost of obtaining the reverse mortgage from a private-sector lender because it exceeds the costs of other types of mortgage loans from such a lender. Usually, there is an insurance premium of two percent of the loan and a two percent origination fee in addition to normal closing costs. Thus, a $200,000 loan would have $8,000 in extra costs. In addition, there is a monthly service charge that is usually added to the total amount.

The loan ends when the homeowner dies, sells the home, or moves out of the home for 12 consecutive months or more (for example, to go into an assisted-living facility). At that point, the reverse mortgage has to be satisfied. If the proceeds exceed the loan amount, the owner of the house or apartment (if moving or selling) receives the difference; if the owner has died, the heirs receive the difference. For cases where the proceeds are not sufficient to pay off the debt, the bank (or insurance that the bank has on the loan) makes up the difference, which is part of the reason for the higher cost.

A reverse mortgage borrower may encounter many financial hazards in taking out a reverse mortgage. First, reverse mortgages are very expensive while promising an uncertain amount of benefits. For example, a typical reverse mortgage may provide to a consumer with a $300-per-month payment with a monthly compounded interest rate of one percent. Over the course of ten years, the borrower will receive $36,000, but by that time he or she will owe almost $70,000 – almost twice as much as he or she has received. In addition, reverse mortgages have complex contract terms that are confusing and can greatly affect the overall cost of a reverse mortgage to the borrower.

As an alternative to a reverse mortgage, seniors may want to consider other options to tap their home equity, particularly if they do not think they will remain in the home for at least five years. For example, a home equity line of credit (HELOC), requiring interest-only payments for ten years can be used. These loans typically have very low (or zero) up-front costs. The drawback is that, unlike a reverse mortgage, the borrower must make monthly (interest-only) payments to the lender. These can be made for several years by drawing on the line of credit itself. Of course, the balance needs to be paid off when the house is sold or the owner dies – just as with a reverse mortgage.

Regardless of the senior’s thoughts on a reverse mortgage or any other loan product, the apartment corporation faces no risk in permitting shareholders to obtain one. In fact, as a result of the borrower not being required to make a debt service payment until he/she sells the apartment, there is even a smaller risk to the corporation than there is in a traditional loan. The co-op retains its first lien on the shares and proprietary lease, so if a default occurs in the payment of maintenance or performing any lease obligations, the shareholder or the lender must cure the default or lose its collateral for the loan. The lender has the same lien on the shares and lease as in any other loan product. The advantage to the apartment corporation is that this enables the seniors to meet their financial obligations to the corporation and reduces the likelihood that long-time residents of the building will be forced to sell their apartments because they can no longer afford them.