Three years ago, with his former spouse suffering from cancer, Jim Dorsey decided to borrow against the equity on his Vashon Island, Wash., home with a reverse mortgage. The couple didn’t have children and didn’t plan to move, so a loan that didn’t have to be repaid until Jim died seemed like a good deal.
Dorsey, 69, isn’t so sure now.
The retired high school teacher figures the loan – which netted him a $75,000 lump sum after paying off his existing mortgage – will reduce his home equity by $100,000, compared with what it otherwise might have been, if he lives another decade.
Then again, Dorsey can stay in the house for as long as he pays his property taxes and homeowner’s insurance. Plus, he won’t be liable for the shortfall, if his final loan balance exceeds his home’s value, either because of falling real-estate prices or because he lives longer than expected.
That’s because almost all reverse mortgages since 1989 have been insured by the Federal Housing Administration. The agency collects mortgage-insurance premiums from borrowers, many of which are used to make lenders whole, if borrowers default or if home prices drop.
“The feds are assuming the risk,” he said. “The bank is in the catbird seat.”
That risk has put the FHA’s reverse-mortgage portfolio $5.25 billion in the hole, as worrisome numbers of borrowers fail to keep up with taxes and insurance, or convey their homes to the FHA, rather than go through the expense of marketing and selling their properties.
In response, Congress last week passed legislation sponsored by U.S. Rep. Denny Heck (D-Wash.), allowing the FHA to fast-track changes to stem the deficit. President Obama signed the bill. The agency plans to use its new authority to tighten lending terms that could reduce loan amounts, or even disqualify some borrowers.
Among the proposed changes are requiring a review of applicants’ finances before granting a loan, and mandating an escrow account, to set aside money for taxes and insurance.
The new rules are scheduled to take effect Oct. 1.
The legislation’s passage comes on the heels of an FHA administrative action in April, to steer borrowers to lower-fee, lower-payout loans to reduce stress on the agency’s insurance fund.
Some consumer advocates fear the pending changes could lock seniors out of reverse mortgages or drastically lower their borrowing limits. That’s a worry because retirement experts expect more pension- and savings-poor Americans to tap their home equity after paychecks end.
Heck said his legislation was a “twofer” win for seniors and taxpayers. Giving the FHA quick authority to shore up its reverse-mortgage program of Home Equity Conversion Mortgages (HECM), Heck said, protects against defaults and minimizes the tab for the Treasury.
Heck acknowledged that critics regard reverse mortgages as inherently predatory. Unlike home-equity loans, for instance, reverse mortgages carry origination fees, mortgage-insurance premiums, closing costs and other expenses. Then there are those who believe “the FHA shouldn’t even exist at all,” he said.
Conservative congressional Republicans want to significantly pare back the federal government’s role in insuring private mortgages, including returning the FHA to its original mission of focusing on low-income and first-time buyers.
Erin Reardon, a reverse-mortgage counselor with Solid Ground, a nonprofit anti-poverty group in Seattle, warned that the FHA’s new guidelines could sow more confusion with a product that’s already complicated.
Reverse mortgages are available to any homeowner 62 or older. Borrowers receive a portion of the home’s appraised value, with older seniors allowed to tap more equity. The loans do not have to be repaid until borrowers die, move or sell. They are the opposite of traditional mortgages in that loan balances grow, rather than shrink with interest chiseling away equity over time.
Reardon said one of the attractions of reverse mortgages is that they do not require credit histories or sufficient cash flow. She’s waiting to find out whether the FHA’s new financial-assessment rules might knock out potential borrowers.
Reardon also worried that mandatory reserves for taxes and insurance might leave some seniors with little or nothing from their home equity. The FHA has not issued formal guidelines, but agency officials have indicated the escrow set-asides could equal two years’ worth of taxes and insurance, or even cover the full duration of the loan, which can last 30 years or longer.
As of February 2012, a record 54,000 borrowers, or 9.4 percent of reverse-mortgage holders, were at risk of foreclosure, because they failed to keep up with property taxes and homeowner’s insurance.
The FHA also intends to limit the amount borrowers can draw at the beginning of the loan, possibly tied to the size of the existing mortgage they need to pay off, as well as other types of debt.
“We will get frantic calls from borrowers,” Reardon said. Any time rules change, borrowers are “rushed into getting the loan, when they usually might have taken more time to think about it.”
The number of Americans taking out reverse mortgages fell for a third straight year, to 54,591 in fiscal 2012. But that number is expected to spike in coming years, as more baby boomers finance retirement.
Anthony Webb, research economist at the Center for Retirement Research at Boston College, said the need is being driven by the rising age for Social Security eligibility and inadequate savings.
But Webb put most blame on disappearing pensions. Between 1989 and 2010, the percentage of American workers with defined-benefit pensions that pay specific, promised sums fell by two-thirds, to just eight percent.
“I think more Americans, out of necessity, will turn to reverse mortgages,” he said.
Dorsey, who separated from his spouse, said reverse mortgages come with trade-offs: cash now or equity later. He said fees ate up a substantial portion of his original draw. In exchange, he can stay put in his home, as long as he keeps it in good repair.
“Do you need the cash? If so, then reverse mortgages may be a sound choice,” he said. “Do you value future equity? If so, then reverse mortgages may not be a good choice.”
Reverse mortgages can help cash-poor seniors tap the equity in their homes without moving out. But borrowers often lack a full grasp of how the loans work. They are the opposite of traditional, or “forward,” mortgages: Your loan balance grows – and home equity shrinks – over time.
Homeowners who are at least 62 qualify for reverse mortgages. You must be mortgage free, or have a small balance that will be paid off with proceeds from the reverse mortgage.
You can borrow against homes of any value, but loan proceeds are capped at homes appraised at $625,500. The size of the loan depends on the age of the borrower, the interest rate and required fees. But roughly, on a $200,000 home, a 65-year-old homeowner could take out about $120,000, after closing costs and other fees, depending on the terms of the loan. At 85, the same borrower could get about $155,000.
INTEREST AND FEES
Reverse mortgages have costs similar to those of regular mortgages. For instance, they carry origination fees of up to $6,000 on homes appraised at $400,000 or higher. On top of that, some borrowers must pay an upfront 2 percent mortgage-insurance premium, plus another 1.25 percent annually. Borrowers also incur closing costs, such as title searches, home appraisal, recording fees and mortgage taxes.
Borrowers can opt for lump-sum draws, regular payments or a line of credit. They are responsible for paying property taxes and homeowner’s insurance, to avoid foreclosure. The loans come due when owners move out, sell or die. The final loan balance can sometimes exceed the home’s sale price. The borrowers or their heirs are not liable for the shortfall.
Source: Federal Housing Administration, Consumer Financial Protection Bureau, Center for Retirement Research at Boston College