Shift to Reverse

By Donald Jay Korn
June 1, 2008
¦AdvertisementAs the population ages, financial planning is moving from the age of accumulation into the dawn of distribution. Planners explore the nuances of how to tap a portfolio in retirement. Insurance companies promote the virtues of immediate annuities as a way to lock in lifelong cash flow.

Insurers are now searching for alternative ways to turn equity into income, and some are turning to a product that many planners have previously ignored: reverse mortgages. Despite the housing downturn, many major insurers see these mortgages as the next sure thing. MetLife Bank added reverse mortgages to its product portfolio in 2007. Early in 2008, the company acquired EverBank Reverse Mortgage (formerly BNY Mortgage, when it was co-owned by the Bank of New York).

"We expect to see a growing market for reverse mortgages," predicts Dan DeKeizer, vice-president of MetLife Retirement Strategies Group. "Baby boomers, who are moving into their retirement years now, are used to looking to home equity to maintain their lifestyle."

Growth Spurt

Recent statistics on reverse mortgages may help explain why MetLife is so upbeat. "About 85% of reverse mortgages are home equity conversion mortgages, known as HECMs, which are guaranteed by the federal government," says Tyler Kraemer of Kraemer, Kendall & Benson, a law firm in Colorado Springs, Colo. The number of reported HECMs grew from a minuscule 7,800 in fiscal 2001 to 107,000 in fiscal 2007. For the first half of fiscal 2008 (through March), while housing values fell and credit markets staggered, HECMs maintained the record pace of 2007, with 55,000 approvals. Of all HECMs now outstanding, 73% were issued since October 2005.

Current market developments may take reverse mortgage numbers to new highs, according to Kraemer, who is co-author, with his wife, Tammy Kraemer, of The Complete Guide to Reverse Mortgages: Turn Your Home Equity into Instant Income! "Traditional lenders are focusing more marketing energy on reverse mortgages as an alternative to the traditional mortgage market, which is in a slump," he says.

In addition, in today's market seniors who might have sold a house to raise cash may not be able to get the price they expected from the sale. "Such homeowners are more likely to consider a reverse mortgage," Kraemer says. "Rising healthcare costs also increase the need for reverse mortgages, as does the poor financial performance of many people's retirement accounts in today's difficult stock market environment."

Red Flags

As demand for reverse mortgages increases, along with lenders' marketing efforts, many planners express caution and skepticism. "Reverse mortgages have enormous fees and should probably be avoided when possible," says Bobbie Munroe, who heads Fraser Financial in Atlanta. Nevertheless, she is now working with a client who might take out a reverse mortgage in the future.

John LeBlanc, a principal at Back Bay Financial Group in Boston, agrees that reverse mortgages are expensive. In addition, he says, "the amount that you can obtain is generally smaller than consumers expect, especially in the Northeast, where the amount a person can borrow is relatively small in relation to the value of the property."

With a HECM, the property value on which a home loan can be based is capped at $362,790 or lower, depending on location. Moreover, Kraemer points out, "today's lower home values mean lower loan amounts, because one of the factors in determining the amount of a reverse mortgage loan is the appraised value of the home."

To help decide whether a reverse mortgage makes sense, planners and borrowers need to know the basics. Reverse mortgages are secured by the equity in a principal residence. They may be taken as a lump sum, a line of credit or a stream of payments. "We are seeing many hybrid loans," DeKeizer says. "A borrower will take out some cash to pay off debts, bills and so on. The balance of the loan might be set up as a line of credit that grows over time."

Federally backed HECMs, the most common reverse mortgages, are available to homeowners who are 62 and older. Borrowers must have a home that is debt-free or nearly so in order to get these loans.

"HECMs are adjustable-rate, non-recourse loans that do not need to be repaid until the last surviving borrower dies, moves out or sells the home," Kraemer says. That's true even if the loan balance exceeds the home's value, he adds.

In some arrangements, cash flow will continue as long as the borrower is alive and occupying the home. The loan plus accumulated interest must be repaid when the owner dies or moves out of the house. In the majority of cases, the family will sell the home to raise cash for repayment.

Serving Septuagenarians

Given those ground rules, which clients might benefit from a reverse mortgage? Many experts feel the ideal reverse-mortgage candidate is someone in his or her mid-seventies who has substantial equity, plans to remain in the home for at least five years, and has no other source of needed cash Kraemer says.

Indeed, Munroe remembers discussing reverse mortgages with a 76-year-old client who lives with her 94-year-old partner in a $200,000 home that she owns free and clear. "The boyfriend pays her $1,400 a month for rent," Munroe explains. "My client's only other assets are a small annuity and a small amount of investments, while her only other income is a modest Social Security check. So when the boyfriend dies, she will be hard-pressed for income."

According to Munroe, the client had been approached by a reverse-mortgage salesman who was going door to door. "Thankfully she wasn't taken in and didn't sign on the dotted line right then and there," Munroe says. "For her, though, a reverse mortgage at some point in the future might be a good solution."

For now, things are on hold for Munroe's client; she doesn't need the money yet and isn't sure that she'll stay in her home much longer. She'll probably make a more lasting housing decision in the next few years.

"The current home is on multiple levels, so a change is probably in the works at some point," Munroe explains. "However, before we do anything, she will need to decide exactly what she does want in terms of housing."

Munroe would like to see this client wait until age 80 before taking a reverse mortgage. "Her payment would be higher then," she says. "At that time, we'll compare the benefits of the reverse mortgage versus selling and using the capital to pay rent and provide income."

This client's family has a history of longevity; her mother was 104 when she died. Since it's not unlikely that the client will live past her average life expectancy, a reverse mortgage with lifetime payouts may work well.

"Before choosing a reverse mortgage, we will certainly shop around for fees, payout and the company's ability to make the payments," Munroe says. "Hopefully, terms and conditions will become more consumer-friendly in the intervening years."

It's Better to Wait

Reverse mortgages are similar to immediate annuities in this respect: The longer one waits before originating the arrangement, the greater the amount of annual cash flow.

"An 80-year-old woman contacted me concerning using a reverse mortgage," says Carol Friedhoff, who heads Savvy Outcomes, a planning firm in Columbus, Ohio. "Her husband had died recently, and her income was cut in half due to pension and Social Security reductions. She wanted to live in her home for at least 10 more years and did not need to pass the home to her family."

After conferring with Friedhoff, this client chose to look into a Fannie Mae reverse mortgage. "With about $300,000 of equity in the home, she would receive approximately $800 per month," Friedhoff says. "Her adjustable rate would be 6% now, and her fees would be less than 4% of appraised value. When I spoke with this client recently, she told me she was planning to move forward with the reverse mortgage."

According to government statistics, the average age of HECM borrowers is 73. DeKeizer says that number may come down as boomers retire and tap home equity via reverse mortgages, but for now these loans tend to go to homeowners who are well into their Medicare years.

Scam Prevention


Products aimed at the elderly seem to lure predators, and that applies to reverse mortgages. "If you are interested in a reverse mortgage, beware of scam artists that charge thousands of dollars for information that is free from HUD," the U.S. Department of Housing & Urban Development warns elderly homeowners.

"Overly aggressive marketing by some lenders has led to situations in which seniors have been pressured into making bad decisions," Kraemer says. "As a result, regulators are starting to talk about the need to maintain and enhance existing consumer safeguards." Currently, he says, would-be borrowers must meet with a HUD-approved counselor before applying for a HECM.

Not only regulators but also legislators are eyeing reverse mortgages. Kraemer reports that both houses of Congress have passed versions of a bill that will replace the county-by-county loan limits with a single national loan limit, eliminate the cap on the number of HECMs that the Federal Housing Administration is authorized to insure, authorize HECMs for home purchase, broaden the types of qualifying properties, and limit HECM origination fees. Kraemer expects the House and Senate to finalize the bill soon.

These new regulations could be major changes, especially the idea that reverse mortgages can be used to purchase new homes, rather than requiring borrowers to age in place. "This provision, along with raising the loan limits and eliminating the cap on the number of HECMs that can be originated each year, will expand the market for reverse mortgages," Kraemer says. Limiting origination fees may also make the loans more appealing to borrowers.

All of these trends are converging to bring reverse mortgages into the mainstream—and into financial planners' potential plans for retired clients. But, warns Kraemer, "the planning that's involved in deciding whether a reverse mortgage is right for someone is surprisingly complex. You need to consider the origination fees as well as monthly servicing fees, the estimated term of the loan or the life span of the borrower, the borrower's financial needs over that time, the interest rate, the available loan amount and how the loan proceeds will be used."

A Fallback Income Stream

What's more, a reverse mortgage need never be consummated to play a valuable role in financial planning. Just the idea that one is available can keep clients on a recommended route.

"I remind my older, retired clients that they need to continue to bear the risks of the stock market with some of their retirement capital," says John Smartt, a CPA and RIA in Knoxville, Tenn. "I also tell them that if stocks go down and stay down for years, they will have two aces in the hole. The first ace is a reverse mortgage. Although a reverse mortgage will have high initial fees, there is no repayment obligation, and the money received won't be subject to taxes."

The second ace, according to Smartt, is an immediate annuity. As with reverse mortgages, the older a client is when making this arrangement, the more income he or she will receive. "This explanation helps clients to feel more comfortable taking stock market risk, even when-as in the past six months-stock markets don't look or act positively," Smartt says. "If it gets them off the sidelines, that's a positive outcome."

So far, Smartt says, stock markets have not dropped far enough or stayed down long enough that his clients have had to play these aces. Nevertheless, knowing they are there may enable people to stick with stocks long enough to realize the long-term performance that equities historically have provided.