Bank Investment Consultant
The reverse mortgage is an investment product that has existed on the margins of the home lending market for years, but retirement savings (or their lack) are pushing reverse mortgages into the mainstream.
Wall Street is increasingly looking to the product as a potential industry growth engine, thanks to the 78 million baby boomers about to retire. Many have major equity in their homes but not enough savings for their retirement years.
This may underlie the recent growth in reverse mortgages. Half of all such loans ever issued were made in the past two years, and 2007 could be the product's biggest year yet. Last year the 76,276 federally insured reverse mortgages made up about 90% of the market, according to the Federal Housing Administration.
The 2006 figure was up 77% from 2005; however, the product's penetration remains just 1% of the mortgage market — leaving lots of room to run for a growing number of lenders.
The mortgage industry is undergoing "cataclysmic change," said Dennis Haber, an executive vice president at Senior Funding Group in Hicksville, N.Y., which specializes in reverse mortgages. "Eventually reverse mortgages will be like conventional mortgages. But we're still in the infancy of changes."
Bank reps will want to recognize which customers are good candidates for reverse mortgages as more institutions offer them and more people inquire about them. Reverse mortgages have typically been used by older clients with an income shortfall.
For example, Clifford Staub, a financial planner in Middletown, Conn., was working with a widow in her 70's who had made some poor investment choices and found herself, even with Social Security, a pension, and a part-time job, barely able to pay her expenses. She took out a reverse mortgage to supplement her income "and is trying very hard not to use it," Mr. Staub said. "But it has greatly reduced her financial and emotional stress."
With a reverse mortgage, homeowners who are at least 62 years old can tap the equity in their home without selling the house or taking on a home equity loan. The key is that the homeowner does not make payments — the lender pays the homeowner a lump sum, makes periodic payments, or sets up a line of credit (or some combination of the three). Homeowners do not have to repay the loan so long as they live in the house. The loan is repaid when the borrower dies, sells the home, or ceases to use it as a primary residence. The amount owed the bank can never exceed the value of the home at sale.
How much can be borrowed depends on factors such as the client's age, the home's value and location, equity in the house, and interest rates. In general older borrowers own more valuable homes, owe less on them, and can borrow more.
Federal rules also play a role: Roughly 90% of reverse mortgages are insured by the government, which caps how much of a home's value can be tapped. The limit for urban homes is $362,790; for most rural areas, it is $200,160. Jumbo reverse mortgages, which are not insured by the government, are available through private lenders but often at interest rates that are 200 basis points or so higher than on the insured loans.
Barry Taylor, a financial planner in San Francisco, said his two biggest complaints about reverse mortgages are the caps on how much a homeowner can borrow and the fees involved.
In states such as California and New York where real estate has hugely appreciated, the $362,790 cap for federally insured loans on urban property could be just a fraction of the equity a homeowner has built up over decades. And the fees tend to be steep: Many lenders charge a 2% origination fee, and mandatory mortgage insurance adds 2%. With various closing costs, the fees on a $250,000 reverse mortgage can easily run $12,000 or more.
But this may be changing. For years the reverse mortgage market was dominated by Seattle Mortgage and Financial Freedom, a division of IndyMac in Irving, Calif. But now the likes of Bank of America Corp., Countrywide Financial Corp., and Wells Fargo & Co. are targeting the market. Government National Mortgage Association, the federal housing finance agency, announced last fall that it would begin packaging the loans for sale on Wall Street.
All this new competition means that people would do well to delay getting a reverse mortgage, if possible, experts say, because the fees and interest rates are likely to be coming down.
Signs have emerged already that competition is raising caps and reducing fees.
This year, for example, Financial Freedom introduced a product called HECM Advantage that cut the loan's margin over the one-year Treasury bill rate by 50 basis points, to 100 basis points. This half-percentage-point reduction means that a 65-year-old borrower would get roughly $18,400 more in cash on a $350,000 reverse mortgage and save as much as $18,000 in interest accrual during the first 10 years. Meanwhile, Bank of America's reverse mortgage program in Arizona reduced costs to the borrower by cutting the typical 2% origination fee in half.
For this reason, Mr. Taylor said, he counseled a 70-year-old widow who wanted to stay in her house but was having cash-flow problems to increase her IRA distribution and put off getting a reverse mortgage. Given these products' high expense, a home equity line of credit could be a much less expensive option, he said. A simple home equity line also taps into the equity in one's home and is much cheaper to set up. But it may not be available to senior citizens with poor credit histories.
Another concern, said Senior Funding Group's Mr. Haber, is that the equity in one's home is not money to squander. "It's the last big pool of money most people will ever have," he said. "You need to treat it carefully."
As reverse mortgages go mainstream, they are being incorporated into various retirement strategies that go beyond simply increasing cash flow and letting seniors stay in their homes, said Jim Mahoney, the CEO of Financial Freedom. The most common retirement strategy is to use reverse mortgage proceeds for medical expenses or to pay for long-term-care insurance.
For the wealthy, there are uses that can add flexibility to wealth transfer and estate planning strategies. "The view in the financial planning community is more that the reverse mortgage is a retirement planning tool," Mr. Mahoney said. "A reverse mortgage takes an illiquid asset that ties up maybe 30% of clients' wealth and does something with it."
For example, a reverse mortgage can fund a single-premium life insurance policy, which is often used to pay estate taxes.
This is valuable if a family's wealth is tied up in illiquid holdings, such as real estate or a family business.
A reverse mortgage might also be preferable to liquidating highly appreciated stock, which would trigger a big tax bill. And in all of these uses, the size of the taxable estate is reduced by the size of the loan on the home.
Wealthy people might use a reverse mortgage to cover a grandchild's college expenses, fund a 529 college savings plan, help with the down payment on a grandchild's first house, or create a family foundation.
