Chapter 20 Mortgages—In Reverse

“A conventional mortgage will turn your income into equity,while a reverse mortgage will turn your equity into income.”

Do I Need to Read This Chapter?

● Am I house-rich but cash-poor? ● Do I need income during retirement? ● Am I aware of the advantages and drawbacks of reverse mortgages? ● Do I realize that such mortgages offer a variety of payment plans?

In the previous chapter,we discussed the conventional mortgage.Let’s reverse the topic and take a regular mortgage and stand it on its head. In other words,rather than borrowing a lump sum of money and paying it back monthly,let’s get the entire loan in a lump sum or in monthly payments sent to us;and then we’ll pay it back only if we sell the house or,better still,have our heirs pay for it at the time of our demise.In other words,you can live in your house for the rest of your life,receive monthly income or get payments anytime you want,and have your estate pay for all this after your death.It costs you nothing! The growth of RMs has been phenomenal.In 2001, only 8,000 were accepted,in 2005 over 48,000,and in 2006,86,000 RMs were transacted.

How Can Reverse Mortgages Make Retirement Easier?

The beauty of reverse mortgages will be appreciated by the millions of retirees who have found it difficult,in today’s economy,to make ends meet.It is true that most retirees own their own home,with a great deal of equity in it,but they do not have sufficient income to live their remaining years in the lifestyle that they have dreamed about.Most of these people are house rich and cash poor.Certainly they can sell their home for additional cash,but then where would they live? They can borrow through home equity loans (only if they qualify and have sufficient current income,which most do not),but they must still pay back a portion of the debt each month.

What to do? The answer is the reverse mortgage (RM)! Bear in mind that the topic of reverse mortgages can be a lengthy and complicated one.I will attempt,in the next few pages,to give you a clear,concise overview of what this program is all about,but more research on your part is needed.

What Is a Reverse Mortgage?

The reverse mortgage is a home loan that is treated in the opposite fashion of a standard mortgage, because the money goes from the lender (a bank,for example) to you,the homeowner.In other words,instead of your borrowing a large amount of money and making small monthly repayments to the lender,you borrow small amounts over a period of years,even for the rest of your life.

You do not give up any ownership when you take out an RM.All privileges of ownership stay with you as well as all responsibilities (taxes,insurance, maintenance,etc.).If you sell your home,the money that is owed becomes due and will come from the proceeds of the sale of the home.If you die before any sale is made,your estate will pay the amount that is owed.

Who Is Eligible for a Reverse Mortgage?

To be eligible for an RM (lenders have different requirements) you must own your home (single family,condo,co-op,townhouse,or a two-to-four unit dwelling),and you must be at least 62 years age.You do not want to be too

young (in your early sixties) to take out an RM since your monthly income will be much less than if you were 10 years older.The reason that older people get a higher monthly income is that they have fewer years left to live,the value of their home will have increased,and the possibility of one of the spouses becoming widowed is greater.

As for payout methods, many possibilities are available to you: 1.Single lump-sum payment 2.Lifetime monthly advances (most popular) 3.Monthly advances for a specific period of time 4.A line of credit (my choice) 5.Any combination of these payment methods

Monthly payments,credit line withdrawals,and lump-sum payments to homeowners are not to be considered as income for tax purposes.The income also does not affect social security and Medicare benefits.

What Is the Structure of the Reverse Mortgage?

All reverse mortgages are known as “rising-debt”loans because the amount you owe grows larger over a period of time.After you receive your first monthly advance,that is the amount that you will owe.But the next month you will receive more money,and that is added to what you already owe from the month before.The pattern goes on for each month that you live.You own the home during your lifetime,and the title rests with you.However,after your demise,if your heirs fail to repay the loan,the lender has the right to foreclose the property.Most RMs allow you to repay the loan at any time.

Medicare and social security eligibility are not based on either your assets or your income.Therefore,whatever advances you receive from the RM will not affect any benefits you receive from public programs.If you receive SSI,RM monthly advances will not affect your benefits as long as you spend the money within the month you receive it.

Bear in mind,and this is most important,that all income you receive from the RM (whether monthly or in a lump sum) is nontaxable.That means that you get to keep every penny you receive.

What Are the Drawbacks?

Of course,certain disadvantages are attached to the RM.The costs attributed to reverse mortgages (closing fees,points,etc.) are usually higher than the costs of other loans,and the interest rates charged by the lender are on a compounding basis.Because these fees can be high,you should plan to take out the RM only if you intend to live in the house for a long period of time.Also,this type of mortgage will give your heirs less equity in the home you leave them.

And another point to ponder:if RMs are as good as they appear to be for older homeowners,why have so few seniors made use of them? The reason lies in the fact that the terms of such agreements are harder to understand than those of other types of loans,going beyond the comprehension of most retirees.Another question to raise is that if reverse mortgages do represent a very lucrative market for lenders,why have most of the financial institutions ignored them? The answer is that an insured RM is neither a simple loan agreement backed by real estate nor a simple life insurance or annuity policy funded with cash.In other words,both banks and insurance companies must stretch their expertise way beyond their normal boundaries in order to design and market this product,which is both risky and expensive.Because of the complexity of the reverse mortgage,you must meet with a counselor (who will examine the reverse mortgage with you) before your application can be accepted.After the meeting,closure could take about two to three months for completion.

How Is the Amount of Payment to You Determined?

The amount of money you receive from your lender will depend upon three factors:

1. Age.How old you are at the closing of the mortgage will determine,in part, the amount of your income.Naturally the older you are,the more money you will receive,since you have fewer years left to receive this income.If you are

married,some lenders will use the age of the younger spouse;others will average the two life ages together in order to determine their payment to you. 2. Equity.The value of your home will determine the monthly income you will receive.Some lenders may have minimums or maximums on the value of your home.For example,at today’s current rates,a person age 70 with a $200,000 house could receive $700 monthly for life or $113,000 in a credit line. 3. Costs.The costs of closing fees,insurance,and interest will determine the net amount of your monthly receipt.There is now a method for homeowners to determine the potential cost of a loan.It is known as total annual loan cost (TALC),which is a disclosure form that all lenders must provide to anyone interested in securing a reverse mortgage.This program will inform the borrower of the approximate total annual cost of the loan expressed as an interest rate.It gives the homeowner the real cost of the loan by showing the total annual percentage rate (a) after two years,(b) at life expectancy of the homeowner,and (c) at some point beyond life expectancy.Because the effective cost of an RM decreases the longer it is held,the form reflects different costs for different time periods.TALC rates make it possible for homeowners to compare the actual cost of reverse mortgage programs with very different types of itemized costs.

Let me clarify the major difference between a standard (also known as forward) mortgage and a reverse mortgage. In a standard mortgage, your monthly payments to the lender become equity for you in the future, whereas in a reverse mortgage you turn your present equity into monthly income (as a debt). In other words, a standard mortgage builds up your equity with each payment you make, while a reverse mortgage spends down your equity with each payment you receive. Remember, you can never fall behind or even have late payments since there are never any payments due on your part.

What Types of Plans Are Offered?

You’ll want to select the method of income payment that suits your lifestyle and situation.Generally,lenders offer three plans: 1.The tenure plan provides monthly repayments to you for as long as you live in your home.These payments will continue until you die,sell,or move away.

2.The term plan provides a monthly advance for a specific number of months that you select (higher income each month than the tenure plan).When the time period runs out and the lender’s repayments to you cease,you are not required to make payments back to the lender as long as you live in the house. 3.The line of credit lets you decide when you would like additional cash.If you combine the tenure or term plan with the line-of-credit plan,you will have not just income each month but also the option of meeting any unexpected expenses (having to leave your home for health reasons,for example) that may occur in the future.Remember that your concern is in the future, because that is where you will be spending the rest of your life.

What Other Information Should You Know about the Reverse Mortgage?

1.Watch out for the “default”clause that appears in some contracts.This acceleration means that certain conditions could force you to sell your home before you die.These may include an extended stay at a nursing care facility,failure to pay property tax,failure to maintain and insure the property,personal bankruptcy,fraud,and condemnation proceedings. 2.Look to see if there is an “appreciation sharing”clause that permits the lending institution to share in any appreciation or increase in value of the home upon its ultimate sale. 3.Remember that an RM is a loan only against your home equity;thus you can never owe more that the value of your home at any time.This limited liability is known as the nonrecourse limit,stopping the lender from seeking more money from your other assets or from your heirs.In other words,if you should live many years more than was initially anticipated (thus receiving more income than your house is worth),the lender cannot go after your estate to make up the difference. 4.Look at the RM in the same manner as a single-premium annuity policy.

Under the annuity concept,you receive a monthly income for the rest of your life by taking money out of your capital and paying one lump-sum payment in advance.The reverse mortgage works in a similar fashion,but instead of giving the lender a large amount of money,you merely put up your house as the collateral for the funds.The big difference is that you still have your capital.

5.The lending institution that holds your reverse mortgage will get the money it paid to you (principal,interest,and costs) when the home is sold. Let me emphasize how crucial it is to examine these costs carefully.Although the interest rate that is charged to you is the one that is most visible,expenses can vary considerably and may include origination and insurance fees,interest on loan advances,and,of course,closing costs.The best method to treat all the various charges involved in the process is to insist that all loan costs be combined into one single rate.This is known as the total annual percentage rate (TAPR),which will show all costs that will become due at the loan’s maturity. 6.The lender must send you monthly advances until you sell,give away your home,or die.At that time,under any of these conditions,the money owed is paid back to the lender.However,the vast majority of homeowners will never themselves actually pay back the money that has been advanced to them.Rather,the amount owed will be paid after their death by their estate, normally from the sale of the house.What you are actually doing,then,is using and enjoying the money “while you are living.”After your demise, your heirs will meet your obligations and retain whatever is left for themselves.Remember that you are not taking any money out of your children’s pockets,as they are not paying anything that you owe from their personal assets.What you are doing instead is leaving them a little less.However,you should inform them of the RM because they will have to pay off the RM debt if they decide to keep the house in the family.In other words,you are spending part of your children’s inheritance.

And on the topic of children,when you teach your child,you teach your child’s child.

It’s a Wrap

● Reverse mortgages may be an ideal solution for those who own their home “free and clear”but have little monthly income. ● You do not give up any of the benefits or responsibilities of homeownership by holding a reverse mortgage. ● You do not repay a reverse mortgage unless you sell,move,or die (in which case,the estate is responsible). ● Reverse mortgages allow you to draw down the equity in your home through a lump-sum payment,monthly advances,or a line of credit.

● Payments enjoyed through reverse mortgages are not considered as income for purposes of tax,social security,or Medicare. ● Reverse mortgage lenders may be hard to find.If you do locate one,you may pay high closing costs to secure your loan. ● You can repay a reverse mortgage at any time. ● If you owe money on your reverse mortgage when you die,your heirs must pay the balance (normally from the sale of the house).

“Aspire to inspire before you expire.”