How Reverse Mortgage Rule Changes Affect Seniors
Recent changes in federal rules that make it more difficult for seniors to get a reverse mortgage are meant, in part, to protect seniors from themselves, experts say.
By lowering the maximum loan amount that can be taken out of a home in equity by 10-15 percent, borrowers will be less likely to use the money when they're in financial distress and use it more as part of a retirement plan.
"It made it safer for the consumer," says Al Hensling, CEO of United American Mortgage, a direct lender in Irvine, Calif., of the new rules by the Federal Housing Administration, which insures most reverse mortgages. "It's somewhat that they're trying to save the consumer from themselves."
With a smaller lump sum available, borrowers may be less inclined to spend all of the money at once and use it to solve other debt problems. There are also reverse mortgage rule changes that make it more expensive to withdraw more money, and that they have enough money to pay property taxes and insurance, and thus stay in their homes.
What's a reverse mortgage?
A reverse mortgage is a loan with the borrower's home as collateral. Homeowners must be 62 or older and have substantial home equity.
Money from a reverse mortgage is typically used to pay bills, for health care, or as an additional source of retirement income. Unlike conventional mortgages, borrowers aren't required to make monthly payments.
The loan, plus interest, is repaid only when the borrower moves or dies. If the lender sells the home for more than the loan amount, then the borrower or their heirs gets the remainder.
The most popular reverse mortgage is the government-insured Home Equity Conversion Mortgages, or HECM. The Federal Housing Administration backs loans for up to $625,500, providing insurance to the borrower against the risk that the lender can't make the contracted payments; and to the lender against the risk that the loan balance will exceed the property value when sold.
Loans can be taken out as monthly payments, a lump sum, or line of credit. The credit line rises over time with the interest rate.
There are four main rule changes, some of which went into effect in September 2013, and others earlier this year:
Maximum loan amounts changed
The two types of reverse mortgages were consolidated into one that lowers the maximum that can be borrowed by about 15 percent less than the previous rules did. The new program allows up to 57.5 percent of the house value to be borrowed.
Borrowers are also charged 0.5 percent of that amount as the mortgage insurance premium at closing, much less than the 2 percent charged under one of the previous programs.
"They've essentially reduced the amount of money that a person can get straightaway," Hensling says.
Initial withdrawals reduced
The new program limits homeowners from borrowing more than 60 percent of the maximum loan amount at closing, or in the first year after closing.
They can take out more, but only to cover "mandatory obligations" such as paying off an existing mortgage or making repairs required by the lender. Credit card debt isn't considered a mandatory obligation.
"One of the highest risks is people who take the full loan proceeds at closing," says Linda Sands, branch manager at Luxury Mortgage Corp. in Garden City, N.Y.
That can create more risk for the borrower and the government, especially if borrowers lost jobs during the Recession and needed a reverse mortgage to pay daily expenses, and still didn't have money to pay the taxes and insurance on their home. Nearly 10 percent of HECM borrowers in 2012 were in default because they didn't pay property taxes or homeowners' insurance premiums, Hensling, says, which is double the default rate in the traditional mortgage market.
Fees for homeowners who take out more than 60 percent of the total amount available in the first year will pay a higher upfront fee. The upfront mortgage insurance premium can be wrapped into the loan, and is 2.5 percent of the appraised value of the property.
People withdrawing less than 60 percent will pay 0.5 percent of the value of the property.
A second fee, called the annual mortgage insurance premium, remains at 1.25 percent of the outstanding loan balance.
Ability to pay checked
Beginning in January this year, lenders must assess a borrower's ability to pay property taxes and homeowners' insurance premiums. It's based on credit reports and an estimate of the homeowner's "residual income" after paying basic expenses such as income taxes, debt payments, alimony and child support, home maintenance and utilities, and real estate taxes and insurance.
A single homeowner needs a "residual income" of $540 to $589 per month, and a couple needs $886 to $998 per month to qualify for a reverse mortgage.
The point is to ensure homeowners can afford to stay in their homes, and aren't evicted. The credit check and the requirement of having the ability to pay may lead to less people qualifying for a reverse mortgage and should lead to fewer defaults, Hensling says.
Fewer big banks involved
Wells Fargo, Bank of America and other large banks have gotten out of the reverse mortgage business, mainly because home values fell so much during the Recession. They might have also not liked the bad press that comes from foreclosing on an elderly homeowner who can't afford to pay property taxes, Hensling says.
Smaller lenders, such as his company, got into reverse mortgages because while they're still labor intensive to originate and have a lot of compliance issues, they can still be very profitable if run well and are FHA backed, he says.
For elderly homeowners who have built up a lot of equity, a reverse mortgage can still be a good way to finance their retirement, especially if their home is their only investment.