Many financial advisers have jaundiced opinions about reverse mortgages, but
as Mary Beth Franklin noted in last week's issue of InvestmentNews, many of the weaknesses of the original reverse mortgages have been fixed.
In other words, these are not your father's reverse mortgages, and advisers should take another look. They might find the new version can help deal with some of the financial problems with which their older clients are struggling.
Financial advisers have criticized reverse mortgages for a number of reasons: They are confusing, and many people have obtained them without fully understanding the terms and conditions. They can have high upfront costs: Borrowers may have to pay a fee for counseling; there is an origination fee charged by the lender; and there are appraisal fees, title insurance fees, credit report fees, etc. There's also an initial mortgage insurance premium paid to the Federal Housing Authority. And the interest rate on a reverse mortgage might be higher than on a conventional mortgage.
INTEREST OWED
Any distributions from a reverse mortgage, whether as a lump sum or regularly monthly payments, are subject to interest that compounds throughout the life of the loan. That means interest owed quickly balloons and could deplete the entire available equity. Standby lines of credit increase by the same rate of interest as borrowed funds, but do not require repayment unless actually used. Under the old rules, spouses younger than age 62 at origination were exposed, because if an older spouse passed away the reverse mortgage balance came due.
Some critics were concerned that reverse mortgagees might opt for lump-sum distributions and spend all the money in the first year or two, leaving them worse off than before.
Most of these issues have been solved, or at least ameliorated. For example, borrowers seeking FHA-insured reverse mortgages must take a counseling course to help them understand the terms and conditions.
Borrowers must demonstrate their financial ability to pay the various costs and must have a satisfactory credit history. Further, many of the closing costs typically are paid out of the initial principal amount, easing the upfront burden on the borrower.
To offset the possibility of the borrower burning through the money quickly, the amount that can be drawn in the first 12 months is restricted. Spouses who were younger than age 62 at origination now can remain in the home without having to pay the reverse mortgage balance as long as they keep up with the property taxes and homeowners insurance. And initial set-up fees have been reduced and mortgage insurance premiums have been cut, so the reverse mortgage is no longer so costly.
It's time for skeptical advisers to reexamine their attitudes toward reverse mortgages.
First of all, reverse mortgages allow retirees to convert the equity in their homes into a liquid asset pool. A reverse mortgage could help a client meet high and unexpected medical costs that might otherwise have forced them to sell the family home and move into a rental, a disruption someone dealing with serious illness does not need.
In fact, in a 2010 survey of elderly Americans, 81% of respondents cited the desire to stay in their homes until death as a reason for seeking a reverse mortgage, and 48% cited financial difficulties.
Retirees don't have to spend the reverse-mortgage money. They can open reverse-mortgage lines of credit and draw on them only in the event of an adverse financial development, giving them financial security and flexibility. The flexibility is enhanced by the fact that distributions from a reverse mortgage are tax-free.
In short, a financial adviser might be short-changing his clients by not taking another look at the utility of reverse mortgages and considering if such a mortgage might not be a useful enhancement to many financial plans.
