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The New Reverse Mortgage Calculation for Retirees


Reverse mortgages, decried for years as loans of last resort for struggling seniors, have had a makeover.

For decades, the image of the industry has been tainted by horror stories about borrowers facing foreclosure and surviving spouses being evicted. But today, these products — introduced in 1961 — have evolved into tools that, along with federal insurance and oversight, often do what was originally intended: ease the financial burden on retired homeowners on limited incomes who want to stay in their home until they die.

Home equity conversion mortgages, commonly referred to as HECMs, insured by the Federal Housing Administration and overseen by the Department of Housing and Urban Development, provide protections for borrowers that include: limits on the amount borrowers can obtain, so that the elderly do not opt ​​for large lump sum distributions that they cannot afford; default protection if the value of the home falls below the loan amount; and provisions that guarantee the right of the surviving spouse to remain in the home after the death of the borrower.

Reverse mortgages still represent only a small part of the financing options senior homeowners choose to meet their needs later in life. And there are still downsides to HECMs, such as high upfront fees. The burden of repaying the loan, meanwhile, falls on your heirs, although they have the option of keeping the house if they repay the loan.

But for seniors who are worried about outliving their savings and want to stay in their homes until they die, a HECM “may be a product to consider,” says Wade Pfau, a professor at American College and founder of RetirementResearcher. com, an independent resource for retirement income planning. “It’s a way to free up money to pay for long-term care and other unforeseen living expenses,” he says.

Dr. Pfau also notes another advantage: the funds disbursed are not taxed since they are considered a loan advance, unlike other retirement income such as distributions from an IRA or 401(k).

HECMs make up 95% of the U.S. reverse mortgage market, according to the National Reverse Mortgage Lenders Association. Today, there are about 580,000 HECMs totaling about $113.5 billion, according to the association.

Most US owners, however, remain skeptical. A 2019 study by the Brookings Institution found that less than 2% of homeowners age 62 and older had a reverse mortgage of any kind, says John R. Salter, professor of personal financial planning at Texas Tech. University and director of Evenksy & Katz/ Foldes Financial Wealth Management.

“Misconceptions about them continue to abound,” he says. “These are complex products.”

The mecanic

To qualify for a HECM, borrowers must be 62 years of age or older, own and occupy the property as their primary residence, and have the financial means to pay expenses arising from the home such as property taxes, insurance and homeowners association fees.

HECMs are only available through an FHA-approved lender. Borrowers are required to have FHA mortgage insurance and attend an information session with a HUD-certified counselor.

The amount available to borrow, called the “capital limit,” depends on factors such as the appraised value of the property up to the FHA loan limit, the amount owed, the age of the borrower, and interest rates. current interest.

If the borrower chooses a payment plan with an adjustable interest rate, indexed to the constant maturity US Treasury index, then as disbursements are made, the untouched amount can continue to grow at that rate. variable interest. With this option, the loan can be received as a line of credit, allowing the borrower to draw on it for distributions only when desired; or as a tenure (which results in monthly payments over the life of the loan); monthly payments for another fixed term; or a combination of these options. (The beneficiary may also choose to change their payment plan to another available option at any time, provided funds are available.)

If the borrower prefers the fixed rate option for the loan, which can be advantageous when interest rates rise, only a lump sum disbursement option is available.

In the past, many seniors who took out lump sum reverse mortgages spent the money quickly and then ran out of funds to pay for things like insurance and property taxes. This would usually lead to default and eviction if no financial solution could be found.

HECMs seek to reduce this risk by limiting the amount that can be borrowed. (The maximum amount of home equity that can be borrowed was increased this year to $970,800, from $822,375 in 2021.) The FHA also conducts financial assessments of loan applicants to guard against defaults. .

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Another guarantee is protection against declines in the value of a house. “The FHA covers any shortfall between the final loan balance and the net sale proceeds so you never have to worry about being ‘under water’ on the loan if your home’s value drops. “, says Professor Salter.

“That’s because HECMs are non-recourse loans, so homeowners don’t have to pay off a balance that’s greater than the value of their home,” says Steve Irwin, president of the NRMLA. So if a person took out an HECM of $100,000 and the value of the house fell to $95,000 when the borrower died, the estate could sell the house and use the proceeds to pay off the loan balance and the FHA insurance would cover the remaining amount.

With all reverse mortgages, borrowers never give up title or ownership of the property until they die, vacate the home, or default on their obligations as a homeowner. Additionally, under HUD’s HECM program, federal guidelines state that, under certain conditions, a borrower’s surviving spouse can continue to live in the home as long as they keep it as their primary residence, do not move for 12 months and stay current on tax and insurance payments. This is true even when the spouse is not a borrower, as long as he or she was married to the borrower when the reverse mortgage was taken out, keeps the home as their principal residence, and continues to pay the taxes and insurance, according to the NRMLA. .

Some drawbacks

It’s wise to have a financial advisor walk you through the process of deciding if a HECM is right for you and choosing the best payment option, if any. If you miscalculate the payouts, you could outlive the product.

High upfront fees can also be a drawback (although they can often be built into the loan). These include set-up fees, which are capped at $6,000; interest and service charges; HUD consulting fees; appraisal fees and third-party closing costs. There is also initial mortgage insurance which is 2% of the appraised value of the home due in the first year and then 0.5% of the mortgage balance charged annually over the life of the loan. According to American Advisors Group, an FHA-approved lender, for a 65-year-old couple to open a $250,000 HECM on a $500,000 home, the total upfront costs could reach $18,000 or more in certain circumstances.

“Because of the costs, it’s important to shop around and find a high-quality lender that offers great rates,” says Pfau. HUD has a list of FHA-approved reverse mortgage lenders. There is also a lender locator at ReverseMortgage.org. A calculator to help you determine what HECM size you can qualify for is provided by RetirementResearcher.com.

Your heirs should also be aware that interest charges on a HECM can add up significantly over time, especially if you take out the loan in your 60s and stay in the house for another 20-30 years. Most of the proceeds from the sale of the house, in this case, will likely be used to pay off the loan. Also, if you were to sell the home to move into long-term care or assisted living, there might be little equity left to use for that purpose.

The existence of a HECM could also affect your ability to qualify for other government social programs such as Medicaid or Social Security Supplemental Income.

Ms. Ioannou is a writer in New York. She can be contacted at reports@wsj.com.

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