Whenever the subject of reverse mortgages come up, invariably one of the objections that are cited is the perceived high cost of originating a reverse mortgage. Virtually every news media article about reverse mortgages cites the high cost and how it eats away at equity. That is why so many advisors recommend they only be used as a “loan of last resort” when there is no other option.
The opposite is actually true. When all costs are considered, reverse mortgages became the loan of first resort. The fact is that they actually cost considerably less when used as a source of income as compared to a portfolio or continuing to make payments from a portfolio once past the age of 62. Let’s investigate the concerns that both consumers and advisors have about the actual fees and closing costs that are the subject of concern.
Home Equity Conversion Mortgage (HECM) endorsements in March ticked upward in March, rising 3.8% to 4,220 loans. It is yet another month recording over 4,000 loans, marking another increase after February saw the first reduction in volume since December and January. HECM volume previously had been on a downward trend in the final months of 2020 prior to December according to data compiled by Reverse Market Insight (RMI).
Reverse mortgages can be a powerful financial tool in retirement — especially as more Americans age in place. But the product’s design today isn’t meeting many borrowers’ needs.
By design, reverse mortgages are meant to make retirement easier — and keep people in their homes.
Nelson Haynes, who worked at Deering Savings & Loan in Portland, Maine, is traditionally credited with creating the first reverse mortgage back in 1961. He wanted to help the widowed wife of his high school football coach stay in her home after her husband died.
In that era, “people observed that there were a lot of widows,” said Martin Neil Baily, a senior fellow in economic studies at Brookings and the former chairman of the Council of Economic Advisers under President Clinton.
“It was a time when a lot of men had pensions, and when the man died, the pension died as well. So these were women that didn’t have anything much to live on, but maybe they were living in a house that was quite valuable,” Baily said.
Reverse mortgages are surprisingly unpopular considering that they let you spend the wealth locked up in your home without having to sell, protect you from a decline in the home’s value, and even (if you so choose) pay you monthly checks for as long as you live, like Social Security. Fewer than 1% of eligible homeowners have a reverse mortgage, according to a Brookings Institution report.
The word “reverse,” which conjures images of retreat and defeat, might be the problem. Or maybe it’s “mortgage,” which is no one’s favorite financial product. There seems to be an impression that taking out a reverse mortgage is an act of desperation by people who have no choice but to crack open and spend their nest egg of housing wealth.
That’s unfortunate because a reverse mortgage can be a smart choice for a wide range of people aged 62 and older, including ones who are far from desperate. Many people who are well set for retirement have most of their wealth tied up in tax-advantaged savings plans such as 401(k)s. Extracting some money from the house they live in without having to sell it can be a good way to raise cash for big expenses—say, to help pay for at-home health care or their grandchildren’s education.
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Innovative hybrid product, combines aspects of traditional and reverse mortgages to deliver a ‘new world of options’ for homeowners at or near retirement
For many Americans over the age of 60, the pathway to achieving financial security in retirement has become increasingly challenging. They are living longer and often have cashflow shortfalls and carry significant debt – including a traditional home mortgage. In fact, over the last three decades, the number of people over the age of 60 burdened by traditional mortgage debt has doubled to more than 40%i. With historically low interest rates, some homeowners will end up exploring a mortgage refinance in an effort to reduce monthly payments and potentially take “cash out” from their home equity. However, a traditional refi can spell trouble for borrowers over 60 who are charting their course to retirement.
When one or more borrowers have reduced income due to retirement, they may not qualify under traditional loan guidelines due to high debt-to-income ratios.
Those who do qualify can end up tethered to 30 more years of mortgage payments. If ability to make these mortgage payments is dependent upon continued full-time employment, this is not sustainable for borrowers hoping to retire.
Even if the borrowers can qualify for a refinance today, and plan to work for the foreseeable future, an unexpected income loss—through disability, death of a partner or unrelated economic upheaval, like that encountered in 2020 with COVID-19—could leave the borrowers with no feasible option but to sell their home.
The upcoming launch of EquityAvail by leading retirement solutions innovator Finance of America Reverse LLC (“FAR”) is opening up a significant new set of options for homeowners. This product is the first-of-its-kind and will provide a needed option for a large segment of the population looking to improve cashflow and remain in their home for as long as they wish.
The practice, almost without exception, is to deliver HECMs as a stand-alone. HECM reverse mortgage lenders are barred by HUD rule from delivering HECMs in conjunction with any other financial instrument. And every annuity provider we have queried has an internal rule that prohibits annuity sales when the funds used for the purchase have been obtained from a reverse mortgage.
The rationales for these restrictions are flimsy, and their cost to the retirees who are affected by them is enormous.
COVID-19 created major new health risks for Americans at all ages and, at the same time, had a major impact on the economy and daily life, exacerbating a wide variety of retirement risks. The retirement system faced major challenges before the pandemic, but the pandemic and its consequences may change the way people look at retirement issues. This article reviews how COVID-19 changed the economic environment, the work environment and the situation for retirees. It provides insights into employer responses to date and a discussion about what they might do in the future. Organizations that make major changes in employment strategies will also need to revisit their retirement benefits strategies. This article further provides a discussion of retirement risks based on recent Society of Actuaries (SOA) research and includes COVID-19 impacts on the risks. It brings together consideration of retirement risks, the environment before COVID-19, changes in that environment and possible future directions for retirement benefits. In 2020, SOA released a new version of its “Post-Retirement Risk Chart” and several reports on retirement risk and COVID-19. These reports were also used to inform this article.
By Jamie Hopkins and Dr. Craig Lemoine on February 10, 2021
The Academy for Home Equity in Financial Planning at the University of Illinois at Urbana-Champaign believes that certain retirees can have a more secure retirement when home equity is used prudently. The Academy has just released compliance guidance around home equity and financial planning designed to help financial service companies update their language, policies, and procedures, many of which no longer follow best practices in the industry.
The average pre-retiree and retiree in the U.S. today have under-saved and risk running out of money in retirement. According to the Census Bureau, home equity represents roughly two-thirds of the net worth of the average American age 65 and over. A reverse mortgage could be an appropriate solution for those who want to stay in their homes and would prefer more cash flow to pay bills or unexpected expenses. Using housing wealth during market downturns can also improve financial outcomes in retirement by protecting investment portfolios from sequence of returns risk. Prudent use of home equity in a holistic retirement plan – where all the client’s assets as considered for their retirement security – helps advisors serve their client’s best interests and the client’s need for retirement savings to last a lifetime.
Many broker-dealers and financial service firms maintain that a reverse mortgage is appropriate only as a last resort once all other available assets are depleted. There is no evidence that this is the case. Some firms and advisors are not aware that in May 2014, FINRA changed its guidance about the use of home equity for retirement and no longer describes reverse mortgages as a “loan of last resort.”
Several broker-dealers and other advisory firms recently discontinued their prohibition on reverse mortgages and adopted more reflective compliance policies around the current state of the role of reverse mortgages and home equity. They believe their trusted advisors should understand how the product works, its potential solutions, and advise and educate clients effectively to make decisions best suited to their needs and circumstances. They believe that if their advisors are restricted from advising or educating clients on the topic of reverse mortgages and retirement housing planning, they are not serving their clients’ best interests.
It remains up to each compliance department, company, and advisor to set their policies. However, if an advisor is engaged in financial planning and a client wants to consider their plan with and without a reverse mortgage, that advisor should provide the resources to do so. According to FINRA, “Home equity is often a homeowner’s most valuable asset and most precious source of retirement security. Reverse mortgages can be a useful tool for certain older Americans who might otherwise face losing their homes. But homeowners should consider all the risks and explore all of their options before taking out a reverse mortgage, and even then, should use the loan funds wisely.”
Today, many firms’ policies are out of date and limit clients’ ability to get education or advice from their trusted advisor about reverse mortgages. The Academy of Home Equity in Financial Planning has reviewed several broker-dealers and advisory firms’ compliance policies. We offer the following Model Language currently being used by RIAs, broker-dealers, and other advisory firms to help you create or modify existing policies regarding reverse mortgages when updating or replacing existing guidance provided by your firm.
Proposed Guidance on Reverse Mortgage Compliance Policies
A reverse mortgage is a non-recourse loan secured by the home, in which monthly principal and interest payments are not required. Unpaid interest accrues on the loan balance and compounds. The loan proceeds are available as a lump sum (often used to refinance a current mortgage), a monthly payment stream, or a Line of Credit, or a combination.
Advisors and firms may discuss the benefits and drawbacks of a reverse mortgage with clients and provide approved educational materials on the topic.
Advisors are prohibited from soliciting, recommending, or advising a client to use reverse mortgage proceeds to fund securities or insurance products. If a client indicates that he has proceeds from a reverse mortgage for investing, contact Compliance immediately. The solicitation (sale) of a reverse mortgage is a prohibited activity at the firm.
For an advisor or registered representative to advise a client to engage in a reverse mortgage to improve their retirement income outcomes or other stated financial planning objectives, the client must have signed a financial planning agreement. If a RRs/IARs decides to recommend a reverse mortgage product, they must recommend at least three FHA-approved reverse mortgage lenders.
Any conflicts of interest must be disclosed in writing to the client as it relates to the recommendation of any mortgage product, including a reverse mortgage.
More than 90% of reverse mortgages in use are the Home Equity Conversion Mortgage (HECM) and are administered by the Federal Housing Administration (FHA). Loan terms are strictly regulated by FHA and the loan is non-recourse, meaning that neither the homeowner nor his estate can be held liable for a loan amount beyond the value of the house. The loan, even in the credit line format, cannot be arbitrarily canceled, frozen, or reduced by the lender.
The safeguards inherent in the HECM are insured by FHA through borrower premiums that accrue on the loan amount.
RRs/IARs may discuss, model, and recommend a HECM in a financial plan if it is advisable for the client based upon the totality of the client’s facts and circumstances and in light of applicable suitability and best interest standards.
RRs/IARs are permitted to assist a client through the reverse mortgage transaction process, helping to collect paperwork and attending meetings. However, while RR/IARs can attend the client’s meeting(s) with the reverse mortgage lender, they must not be an active participant in the meeting.
PROVIDING REVERSE MORTGAGE EDUCATION FOR CONSUMERS
What is a Reverse Mortgage?
A reverse mortgage is an interest-bearing loan secured by the home. The most used reverse mortgage is the FHA-insured Home Equity Conversion Mortgage (HECM). To be eligible for the HECM, one homeowner must be 62. Younger spouses, known as “non-borrowing spouses” are allowed but benefits are reduced. Some lenders offer private reverse mortgages to individuals as young as age 60.
Like a home equity loan, a reverse mortgage allows you to convert your home equity to cash that you can use for any purpose. Unlike other home loans, however, homeowners are not required to make monthly interest or principal payments during the life of the loan. However, borrowers can choose to make voluntary payments to principal or interest to help manage the cost of the loan. Unpaid interest is added to the loan balance, which is why reverse mortgages are often called “rising debt” loans.
The HECM reverse mortgage loan typically only becomes due when you die, sell your home to move, or otherwise leave your home for more than 12 months—for instance, if a health issue requires the last remaining homeowner to enter a nursing home. (There are special provisions for non-borrowing spouses when the borrowing spouse exits the home that must be considered.)
The loan is due when the last homeowner is no longer using the home as a principal residence. Snowbirds are allowed. When the loan is terminated, you or your heirs must repay the loan which consists of draws, compound interest, FHA insurance premiums, and servicing fees, if any. The loan can be satisfied through the sale of the home, refinancing the loan, or payment from other assets, the same as most options available with traditional loans.
Because interest will have been accruing during the life of the loan, you will likely owe more than you borrowed—and if home values have fallen or you live longer than expected, the loan balance could exceed the home value. But since reverse mortgages are non-recourse loans, the worst that will happen is that you or your heirs will receive nothing from the sale of your house because the full amount of the sale proceeds went to repay the loan. The lenders cannot go after any other assets that you or your heirs own. For further information, read FINRA’s investor alert on reverse mortgages here.
Lenders are prohibited from arbitrarily canceling, freezing, or reducing the HECM loan benefits.
Your financial advisors can help determine what is in your best interest when it comes to financial planning and available strategies or products. Lending strategies, mortgages, and reverse mortgages can play an important part in your retirement income planning.
By Daniel Hunt, Lisa Shalett, Zi Ye, and Stephanie Wang on March 31, 2020
The answer to the question, “How prepared are you for retirement,” depends a lot on whether you look holistically at the balance sheet, including home equity, or just at the portfolio and income sources like Social Security. When home equity is ignored, that can cause households to make suboptimal decisions, such as forgoing longplanned spending it could afford or taking more investment risk than it’s comfortable with. When a questionable decision like that encounters the kind of market downturn we are currently experiencing, it can do serious damage to household ﬁnances and well-being.