Personal Finance

This Is When a Reverse Mortgage Is Actually a Brilliant Idea

John Seetoo

Published: November 26, 2024 5:27 pm

Best known for creating the 1980s title role of the Hawaii-based TV sleuth Magnum P.I. and his current role as Commissioner Frank Reagan on the show Blue Bloods, Tom Selleck is a well-known Boomer and Millennial celebrity.  However, among Gen-Zers, Selleck may predominantly be recognized as a spokesman for reverse mortgages in his nationally syndicated commercials.. 

Reverse Mortgage Mechanics

• The loan proceeds from the reverse mortgage can be a lump sum, a credit line, or installment payments. None of the loan proceeds are subject to taxes.
• The borrower maintains the home as a primary residence and maintains it in agreed-upon condition at the time of the mortgage signing.
• The loan balance increases over time, as interest and fees accrue each month since monthly payments are not required. 
• The borrower must stay current with taxes and insurance on the property. Any default can lead to the loan term immediately maturing, which could trigger asset seizure, foreclosure, eviction, or other steps, depending on the terms of the reverse mortgage loan. 
• The primary downside is the comparatively steep net expense, as the home equity amount erodes as interest and fees compound on the base loan amount.
• Anti-predatory laws prevent unlawful evictions and define the parameters under which the lender can assume title and control of the collateralized property.
• Reverse mortgage loans are “nonrecourse”, so lenders cannot try to claim other assets or those of the borrower’s heirs that exceed the face amount of the original loan.

Negative connotations from abuses that unscrupulous real estate financiers committed with reverse mortgages during the industry’s infancy during the 1960s and 70s, which smeared its reputation. Early foreclosure reports taken out of context instilled unwarranted fears since the bulk of the foreclosures were due to unpaid tax defaults or borrowers relocating from the properties as their primary residences.  

Certain tweaks, innovations, and legislation added to the reverse mortgage model have been enacted over the past several decades that have mitigated a number of the negative risks and downsides. The sector has subsequently undergone reforms and best practices upgrades to become a legitimately viable alternative to utilize home equity as a collateral asset for loans. 

Backed by FHA and HUD

Technically categorized as Home Equity Conversion Mortgages (HECM), a HECM differs from a standard reverse mortgage in several ways: 

• The Federal Housing Authority (FHA) and Dept. of Housing and Urban Development (HUD) insure HECMs, so they can be securitized for a secondary market.  (President Ronald Reagan authorized HUD insurance for reverse mortgages in 1988.)
• The FHA has a $6,000 cap on fees for HECMs.
• Age 62 is the youngest eligibility for applicants.
• HECM interest is now pegged to the 1-year US Treasury rate, so underwriters cannot charge arbitrarily higher interest on the loans.

On the downside, a HECM can impact Medicare and Social Security payment amounts, depending on the borrower’s financial status, net worth, and other parameters, since the Federal Government is involved with all of those programs.

On the pro side: HUD has implemented safeguards to protect non-borrowing spouses from eviction. Thanks to HUD supervision, reverse mortgage defaults dropped from 5% in 2014 to 1.5% in 2019, and HUD counseling services have become a crucial tool in educating borrowers about potential risks for their respective portfolios and implementing metrics for lenders to follow to prevent unexpected hazards.

Jumbo Size!

For asset-rich, cash-short elderly homeowners who cannot get the amount of liquidity they require from a HECM, a Jumbo Reverse Mortgage might be a solution worthy of consideration. Capped at $4 million, this option is valid as long as the borrower has their own equivalent capital sum invested in the property (min. 50%).  Jumbo Reverse Mortgages are not government-insured, so lenders can exercise wider flexibility of latitude in setting terms.  

On the Pro side, Jumbo Reverse Mortgages:

• Start age eligibility at 55.
• Mortgage insurance is not a requirement.
• Larger loan amounts and a range of prospective homes can qualify as collateral.

On the Con side:

• Fees can be more expensive.
• Credit lines may have greater restrictions.
• Lack of government regulation entails a greater risk of scams.

Implementing a Reverse Mortgage With Retirement

As liquid cash is fungible and can be applied in countless ways, reverse mortgage proceeds have found favor in a number of retirement tool capacities, such as:

• Thanks to the historic stock market highs of the last decade, millions of retirement accounts invested in stocks or stock indexes have grown exponentially. A reverse mortgage drawn down as a line of credit can be an effective backstop against market volatility that might ordinarily compel premature and undesired portfolio liquidations.
• Once a prospective borrower thoroughly calculates the costs of a potential reverse mortgage, it might serve as an effective refinance tool to retire high interest credit card debt or other onerous interest rate outstanding debt.
• In one example, a homeowner in a neighborhood with bullish real estate market prices used a reverse mortgage in a home equity arbitrage strategy. Taking a reverse mortgage on his $850,000 home, he paid off his regular mortgage and allowed the house’s value to continue to appreciate. The plan is to leave the property as a gift to his heirs – none of whom would want to move into the home upon his demise. Since the reverse mortgage loan is non-recourse, his heirs would get to keep the extra equity value above the original loan amount, plus interest and fees, which are now capped under HUD rules for HECM transactions.

Options for Heirs

As the majority of reverse mortgages are not repaid until the borrower (or the surviving spouse) passes away, relocates, or decides to sell, heirs in the case of an estate scenario have several options, which can be strategized in advance, like the example above. These choices include:

• A property sale to retire the debt and keep any equity above the loan balance
• Retire the debt out of pocket.
• Retain the property and refinance the reverse mortgage balance if the property’s value is sufficient
• Allow the lender to assume the property’s title if the debt exceeds the property’s value (or the heirs simply don’t want the house) and walk away. 

That last option lets the lender file a claim for any unpaid balance with the insurer (practically always the Federal Housing Administration, or FHA, which oversees Home Equity Conversion Mortgages, or HECMs). The heirs and the rest of the estate are protected from any subsequent or illegal claims that the lender might try to make against them personally on the loan. 

As regulatory guidelines and new financial strategies continue to evolve and upgrade, the stigma over reverse mortgages, already on the wane, should disappear in due course. As a source of liquidity with increasingly flexible deployment choices, home equity loan finance will likely become a common retirement resource in the not-too-distant future. 

This article is intended to serve solely in a general information context. Should more specific retirement strategy, estate planning, and real estate home equity loan specifics and details be sought, 24/7 Wall Street suggests contacting a financial professional for advice.