Are Reverse Mortgages Still Worth It?
I’ve written before about the advantages and disadvantages of reverse mortgages, especially Home Equity Conversion Mortgages (HECM) that are insured and regulated by the Federal Housing Administration (FHA) (see https://www.cognizantwealth.com/2014/02/20/reverse-mortgages-the-good-and-the-bad/). One of the advantages – the fact that you do not have to undergo an income and credit check in order to qualify for the loan – is going to disappear in March. Does that mean it’s time to take reverse mortgages off your list of useful tools for raising money in retirement?
Before answering that question, let’s explore the new rule. Until now, all homeowners age 62 and older living in their homes have been eligible to purchase a HECM without any underwriting to determine credit or income status. Starting in March, however, the FHA will impose income & credit requirements on borrowers. Why the change? It seems that there has been a marked increase in the number of borrowers defaulting on their property tax payments. While such behavior subjects the borrower to immediate foreclosure and eviction under the terms of the HECM, the government has been understandably reluctant – especially in the wake of the 2008 housing crisis – to force elderly homeowners out of their homes and into the streets.
What does this mean for new HECM applicants? Most likely higher origination and servicing costs for everyone, plus a lengthier process before getting the money in hand (although at this point we don’t yet know the extent). But higher-risk applicants will additionally be required to set aside enough cash from the mortgage to pay for their property taxes and homeowners insurance. Those with good credit but who fail the income test will have to set aside enough funding to pay for taxes and insurance on a year-by-year basis (called a partial set-aside). For those that fail both, the new rule requires the set aside to be large enough to cover the tax and insurance payments for their entire remaining lifespans (a fully-funded lifetime set-aside). That could eat up the majority of the loan for borrowers without a lot of equity in their homes.
So are HECM reverse mortgages still worth it? The answer now depends on one’s financial situation. The vast majority of applicants should hopefully see only slightly longer processing times and higher costs. For them, a HECM should continue to be a viable way to utilize the equity in their homes while continuing to live in them. Even those applicants subject to a partial set-aside may still find the HECM to be a good cash generation option. After all, if they want to stay in their homes they need to find some way to pay their taxes and insurance premiums, although it would have been nice if the FHA had allowed them to pay that from sources other than the HECM itself (which is likely to be more expensive). It’s primarily only those in the highest-risk group – the ones subject to the fully-funded lifetime set-aside – for whom a HECM may no longer be the best choice. The better option for them at this point might be to sell their homes and either downsize or rent.
Remember though that a reverse mortgage is just one of many tools available for income generation in retirement. It should only be considered after you have developed a comprehensive retirement plan and strategy. As the saying goes, don’t put the cart before the horse.