Advisers like reverse mortgages, but only in unique circumstances

Home-equity product for clients who plan to stay in their home indefinitely and who could use some supplemental income

Oct 1, 2015 @ 1:10 pm

By Greg Iacurci

Amy Jo Lauber, president of Lauber Financial Planning, has only done one reverse mortgage with a client over the course of her 22-year-long career.

A former client living in North Carolina owned a home worth close to $800,000 and had 100% equity in the property. It was one of the only assets she retained in a divorce from her husband, and she didn't want to move because of her strong emotional attachment to it.

A reverse mortgage helped the woman get an income stream for life and keep the house, according to Ms. Lauber. “It was really only needed in that situation, but it was the right situation and I'm glad we used it,” she said.

Ms. Lauber is one in a large camp of advisers that sees reverse mortgages as a useful financial planning strategy, but one that should only be used in very specific circumstances, not as a catch-all.

Consensus thinking on reverse mortgages is that it's a strategy mainly for clients who know they'll stay in their home for the remainder of their lives.

“For most of us, living in your home, maintaining home ownership and being able to use the equity from the home, that's not bad. Those are important physical, emotional things for people,” said Charlie Douglas, an Atlanta-based financial adviser and editor of the National Association of Estate Planners and Councils' Journal of Estate and Tax Planning.

WHAT ARE THEY?

Reverse mortgages are a type of home equity loan for borrowers age 62 and older that allow homeowners to access part of their home equity in cash. The loan amount depends on home value (capped at $625,500), interest rate and age of the borrower. Unlike with traditional loans, there's no monthly payment — rather, the principal and accrued interest come due when a borrower dies or moves.

Money can be accessed through a line of credit, monthly installments, a combination of those options, or a lump sum. Fixed interest rates are only available via a lump sum.

“For most retired households, especially lower- and middle-income households, equity in their homes is very often by far the largest store of savings they have,” said Steve Sass, senior research economist at the Center for Retirement Research at Boston College.

Nearly all reverse mortgages today are home equity conversion mortgages (HECMs), insured by the Federal Housing Administration. They're non-recourse loans, so if the balance ultimately exceeds a home's value, the government covers the difference, a protection many advisers find compelling.

MARKET SIZE

There are currently only about 628,000 outstanding HECMs, according to figures from the Consumer Financial Protection Bureau. That represents a paltry 1% of the traditional mortgage market, and over 3% of home equity loans and lines of credit.

Loan volume today is less than half what it was at its peak in 2009 — 51,642 HECMs were made in fiscal-year 2014 compared with 114,692 in 2009, according to figures from the National Reverse Mortgage Lenders Association. The market downturn forced people to turn to their home as a source of income, hence elevated volume during the financial crisis, according to CRR.

"It's a very much underused product compared to what we think it can provide,” Mr. Sass said.

Expectations are that the market will grow due in part to a surge in the number of baby boomers becoming eligible for HECMs, according to CFPB. Further, new rules from the Department of Housing and Urban Development make HECMs more attractive for both lenders and borrowers, CRR says.

Annual number of home equity conversion mortgages
Source: Department of Housing and Urban Development
*Through Aug. 31. Data represent the federal fiscal year, beginning Oct. 1.

'VERY SPECIFIC SITUATIONS'

Michael Zmistowski, personal financial planner at Financial Planning Advisors, said he only uses HECMs in “very specific situations,” one of which involved a client with an $850,000 house who was still making mortgage payments at age 70.

Mr. Zmistowski's client used an HECM to stay in his house, wipe out the existing mortgage and eliminate monthly payments.

The percentage of homeowners age 65 and older with mortgage debt swelled to 30% in 2011 from 22% in 2001, and the median amount owed increased 82% to $79,000, according to the most recent data from the Census Bureau.

Aside from mortgage payments, Mr. Sass said HECMs can help get rid of other monthly payments such as taxes, insurance and other fixed expenses.

People can also use them to generate income rather than tap into 401(k) and IRA balances, and to defer claiming Social Security in order to maximize benefits, said Alicia Munnell, CRR's director. Mr. Zmistowski also advocates tapping a device known as an HECM for purchase, which allows consumers to buy a new principal residence with proceeds from a reverse mortgage.

That's a strategy David Peskin, president of Reverse Mortgage Funding, said his mother-in-law is doing to purchase a house in Florida. Rather than using 100% of sale proceeds to buy another home of comparable value, clients can put down roughly 50% on the new house, and take out an HECM on the remainder to free up cash for other expenses.

James Shambo, president of Lifetime Planning Concepts, said the line-of-credit option can help affluent clients during down markets. A line of credit allows borrowers to draw on the loan at the times and amounts they wish, subject to principal limits. Interest only accrues on the amount that's tapped, and the line of credit grows over time on any unused funds.

If there's a market dip more severe than a client's cash flow allows for, Mr. Shambo has clients tap into their credit line while the portfolio is in decline and then assesses when, during the market's eventual recovery, a client could repay the line of credit.

CONS

Reverse mortgages, not unlike just about any other financial planning strategy, is not without its drawbacks.

“Like any financial instrument there are risks or detriments to using that particular instrument,” Mr. Sass said.

For one, costs are somewhat high. On top of accruing interest, there are origination fees, which can run as high as $6,000; mortgage insurance premiums, typically an upfront fee of 0.5% of the home value and an annual fee of 1.25% of the outstanding loan balance; and other costs such as appraisal and servicing fees.

Homeowners must be able to cover typical home insurance costs and property taxes, as well as maintenance and upkeep, otherwise lenders can ultimately force foreclosure.

Other avenues advisers should explore first with clients include taking out a traditional home equity line of credit or downsizing to a less expensive house, because they may be cheaper options than a reverse mortgage, Mr. Douglas said.

Further, for those looking to leave an inheritance for children, borrowers should expect not to be able to bequeath the home, John McManus, founding principal of McManus & Associates, said.

“It's particularly destructive if you need to transfer assets down to your children, and they need the money,” Mr. McManus said, giving the examples of an indigent or special needs child, or a child living at home.

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