Reverse mortgages should be first resort for advisers

Twenty-two years after they were introduced by the Department of Housing and Urban Development, reverse mortgages still aren’t…

Twenty-two years after they were introduced by the Department of Housing and Urban Development, reverse mortgages still aren’t being used by most financial advisers as the viable retirement income vehicles that they can be.

Shunned as being too expensive, confusing and misleading to older homeowners, the reverse mortgage typically is considered a “last resort” by advisers.

But because they allow people 62 and older to stay in their homes and convert home equity into tax-free income, reverse mortgages probably should be an adviser’s first resort. In fact, there are many times when a reverse mortgage can be the best way to stretch a retirement portfolio.

Consider, for example, a 75-year-old who is living in a mortgage-free home valued at $350,000 and has a $200,000 retirement portfolio.

Assuming a desired after-tax annual income of $27,500, a 6.5% annual retirement account investment return and a 2% annual home value appreciation, turning to a reverse mortgage first would generate total income of $590,000 and fund retirement for 19 years. Applying the same criteria to a last-resort strategy, which uses a reverse mortgage only after the retirement portfolio is spent, would fund retirement for 16 years with a total income of $500,000.

The $90,000 difference is created primarily by giving the higher-performing retirement portfolio more time to benefit from market appreciation. A third option, drawing down the retirement account, then selling the home but having to finance other living arrangements, would fund retirement for 16 years with a total income of $475,000.

The analysis was compiled with the help of Generation Mortgage Co., which clearly has a dog in this fight as the nation’s largest independent originator of reverse mortgages.

But that doesn’t make the results any less significant for a financial planning industry that is notorious for disregarding home equity as part of an overall financial plan.

Clearly, the reverse mortgage has its share of warts that will turn off many advisers. One of the biggest issues is the cost, even though all fees are deferred until the sale of the home, the death of the borrower or when the borrower moves out permanently.

In the scenario described above, a $6,000 loan origination fee, $2,000 in closing costs, a one-time 2% mortgage insurance premium, a continuing 1.25% mortgage insurance premium and 5.75% in interest on the loan would all be deducted.

The reverse-mortgage industry has tried to address the fee issues with some flexibility on the loan origination fees and a new “saver” option that spreads the one-time mortgage insurance premium over the term of the loan.

The saver option, which was introduced in October but has yet to gain much traction, is emblematic of the highly charged nature of reverse-mortgage decisions.

“This is a financial decision to be sure, but it’s also an emotional decision because a lot of people are emotionally tied to a home they’ve lived in for 40 or 50 years,” said Harry Gordon, a branch manager at iReverse Home Loans LLC, a subsidiary of Hopkins Federal Savings Bank.

Multiple variables are used to determine how much equity a homeowner can receive through a reverse mortgage, but because the fees are typically deferred for years, the equity received always will be well short of a home’s current market value.

Consider the example of a 69-year-old homeowner with a mortgage-free $500,000 home.

In a standard reverse mortgage, the homeowner would be charged a 4.99% interest rate and $12,600 in deferred closing costs. He or she would receive $316,000.

The saver option would result in a higher interest rate — 5.25% — but would decrease deferred closing costs to $7,500. The saver option has a lower loan limit because the mortgage insurance is deducted over the duration of the loan, not paid upfront, and this homeowner’s equity limit is only $249,000.

In essence, the fees don’t really change much; they just get moved around within the term of the loan agreement.

There is no simple answer as to why people might choose the saver option, which comes with a higher interest rate and smaller loan amount, except that it would save a few thousand on closing costs and allow the homeowner to keep more equity in his or her estate.

But the new twists in the saver option might be exactly what some financial advisers need to help their clients manage the emotional aspect of a reverse mortgage, which should be at least considered as part of a retirement income strategy.

Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].