Tax Tips
Reduced Fees for Reverse Mortgages - May 2009
Richard Scrivanich - Partner
Typically, home mortgages are used to buy a house or other dwelling. The borrower makes monthly payments to the lender, gradually reducing the debt. "Reverse mortgages" flip the equation. The borrower is a homeowner with little or no debt on the house. The lender advances cash in a lump sum or in smaller amounts; the borrower does not have to repay principal or interest as long as he or she remains in the home.
More Money…
Most reverse mortgages are home equity conversion mortgages (HECMs), which are guaranteed by the federal government. They are available only to homeowners who are at least 62.
The federal government caps the amount borrowers can receive with a HECM. Depending on housing prices where you live, the maximum has ranged from $200,160 to $362,790. Under the housing act, the new maximum HECM amount is $417,000 in most areas. In expensive housing markets the maximum HECM goes as high as $625,500. The bottom line is that now HECMs will be more appealing to seniors who live in expensive homes.
…Lower fees
While the new housing act increased the amount you can borrow with a HECM, it also reduced the costs, especially on large loans. The origination fees lenders can charge have been capped at 2% of the home's value or 2% of the local HECM lending limit, whichever is lower. The new law reduced the maximum fee to 2% of the home's value, up to $4,000 on a $200,000 home, and 1% on any higher value, with a maximum origination fee of $6,000.
In addition, the housing act requires HECM borrowers to receive counseling before signing a contract from a knowledgeable third party who is not associated with the lender. Lenders and their affiliates are prohibited from selling insurance, annuities, or other products to HECM borrowers.
Shifting into reverse
Why did the new housing act include reverse mortgage provisions? Possible reasons include the following:
- Increase promotion. Given the current unrest in the traditional housing and mortgage markets, some lenders are devoting more of their marketing efforts to reverse mortgages. Seniors may see or hear more ads for reverse mortgages these days.
- Decreased home prices. Seniors who had planned to sell their home may not be able to get the price they expected because of the housing slump. Those seniors may prefer to raise cash via a reverse mortgage rather than sell at a distress price.
Also, some lenders may urge seniors to take a reverse mortgage now, based on current home equity, rather than wait and see their equity decline further if home prices keep falling. Considering the likelihood that demand for and promotion of reverse mortgages will increase, Washington acted to control their costs and bolster consumer safeguards.
Money from home
Should you (or your parents) consider a reverse mortgage? In order to decide, you should know some of the basics. Reverse mortgages are secured by the equity in a principal residence. The lender may provide one large amount, a line of credit, or an annuity-like stream of cash flow.
In practice, many reverse mortgages are combinations of the above. A borrower might take a portion of the amount a lender is willing to provide and use that money to cover outstanding bills and pay down credit card balances. The balance of the loan amount might be established as a line of credit, and some lenders will arrange for that line to increase over time. With an annuity-like arrangement, cash flow may continue as long as the borrower is alive and occupying the home.
Reverse mortgages may be fixed or adjustable-rate loans. They're generally "non-recourse," meaning that the lender has no claim on the borrower's assets other than the home securing the loan. That's true even if the unpaid interest compounds to the point where the loan balance is greater than the house's value.
Typically, borrowers do not need to repay a reverse mortgage until the last surviving borrower dies, moves out, or sells the home. Once the borrower or borrowers no longer live in the house, the borrower or the borrower's heirs may have to sell it to raise cash to repay the reverse mortgage.
Staying put
Reverse mortgages are offered to home owners as young as 62, but they may have the greatest appeal to people in their mid-70's or older. The older the homeowner, the greater the amount that can be borrowed, as a percentage of home equity. A 65-year-old borrower with a $300,000, debt-free house might be able to borrow around $170,000 with a reverse mortgage, while an 80-year-old in a similar residence might get a $210,000 loan. (The amounts are set by HECM guidelines, which assume that older owners will be in the house for less time and loan repayment will come sooner).
What's more, homeowners should plan to remain in their home for at least five years after they get the loan in order to amortize the upfront cost. If you take out a reverse mortgage and leave the house after one year, you will have paid substantial initial fees for a brief use of the borrowed money. Thus, a reverse mortgage might make sense if you or an elderly loved one has a pressing need for ready cash and a strong desire to remain in that home for many years.
If you have any questions regarding the above discussed topic, or any other tax matter, please feel free to give me a call at (562) 698-9891.
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