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https://www.wsj.com/articles/reverse-mortgages-in-retirement-advice-11654191860

JOURNAL REPORTS: PERSONAL INVESTING

The New Math of Reverse Mortgages for Retirees

Many of the negatives have been addressed with federal insurance and oversight. At the least, they’re worth
considering for people who are cash poor and house rich.

By
Lori Ioannou
June 3, 2022 10:00 am ET

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

For decades the industry’s image was tainted by horror stories about borrowers who
faced foreclosure, and surviving spouses who were evicted. But today, these products—
first introduced in 1961—have evolved into tools that, with federal insurance and
oversight, often do what was originally intended: ease financial burdens for retired
homeowners with limited incomes who want to stay in their homes until death.

Home equity conversion mortgages, commonly known as HECMs, insured by the Federal
Housing Administration and overseen by the Department of Housing and Urban
Development, offer protections to borrowers that include: limits on how much borrowers
can obtain, so seniors don’t opt for large lump-sum distributions they cannot afford;
protection from default if the value of the home declines to less than the loan amount; and
provisions that secure a surviving spouse’s right to remain in the home after the
borrower’s death.

Reverse mortgages still represent just a small part of the financing options that senior
homeowners choose to meet their needs in later life. And there are still some downsides
to HECMs, such as high upfront fees. The burden of paying off the loan, meanwhile, falls
on your heirs, though they have the option of keeping the house if they do pay off the loan.

But for seniors who are concerned about outliving their savings and who want to remain
in their homes until they die, an HECM “may be a product to consider,” says
Wade Pfau,
a
professor at the 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 unexpected living expenses,” he says.

Dr. Pfau notes another benefit as well: The funds disbursed aren’t taxed since they are
considered a loan advance, unlike other retirement income such as distributions from an
IRA or 401(k).

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

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

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

The mechanics
To qualify for an HECM, borrowers must be 62 or older, own and occupy the property as a
principal residence, and have the financial wherewithal to pay expenses arising from the
home such as property taxes, insurance and homeowner association fees.

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

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

If the borrower chooses a payment plan with an adjustable interest rate, pegged to the
U.S. Constant Maturity Treasury Index, then as disbursements are made, the untouched
amount can continue to grow at that variable interest rate. With this option the loan can
be received as a line of credit, allowing the borrower to tap into it for distributions only
when desired; or as tenure (which comes in monthly payments for the life of the loan);
monthly payments for another specified term; or a combination of these options. (The
recipient can also choose to change his or her payment plan to another available option at
any time, provided funds are available.)

If the borrower prefers the fixed-rate option for the loan instead, which can be beneficial
when interest rates are rising, only a lump-sum disbursement option is available.

In the past, many seniors who took out lump-sum reverse mortgages would spend the
money quickly and then lack the funds to pay expenses such as the insurance and
property tax. This typically would 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 against was raised this year to
$970,800 from $822,375 in 2021.) The FHA also performs financial assessments of loan
applicants to guard against defaults.

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Another safeguard is protection against declines in a home’s value. “The FHA covers any
shortfalls between the final loan balance and the net proceeds from the sale so you never
have to worry about being ‘underwater’ on the loan if the value of your home drops,” says
Prof. Salter.

“That’s because HECMs are nonrecourse loans so homeowners don’t have to pay back any
balance than is more than the value of their home,” says Steve Irwin, president of the
NRMLA. So if a person took out a $100,000 HECM and the home value sank to $95,000
when the borrower died, the estate could sell the home and use the proceeds to pay back
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, move out of the house or do not maintain their homeowner obligations. In
addition, under HUD’S HECM program the federal guidelines say that under certain
conditions the surviving spouse of a borrower can continue to live in the home as long as
they keep it as a principle residence, don’t move out for 12 months, and stay current on
paying taxes and insurance. This is true even when the spouse isn’t a borrower, as long as
they were married to the borrower when the reverse mortgage was done, maintain the
home as a principal residence and continue stay current on paying taxes and insurance,
according to the NRMLA.

Some downsides
It is wise to have a financial adviser guide you through the process of deciding whether an
HECM is right for you, and choosing the best payment option if so. If you miscalculate on
the payouts, you could outlive the proceeds.

High upfront fees can also be a downside (although often they can be incorporated into
the loan). These include origination fees, which are capped at $6,000; interest and service
fees; a HUD counseling fee; appraisal fees and third-party closing costs. There is also
upfront mortgage insurance which is 2% of the appraised value of the home due the first
year, 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 house worth $500,000, total upfront costs could reach
$18,000 or more under certain circumstances.

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

Your heirs also should be aware that the interest expense on an HECM can accumulate
substantially over time, especially if you take out the loan in your 60s and stay in the
house an additional 20 to 30 years. Most of the proceeds from the house sale, in that case,
are likely be used up in repaying the loan. In addition, if you needed to sell the house to
move to long-term care or assisted living there could be little equity left to use for that
purpose.

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

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

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