Recent legislation has made the reverse mortgage less
costly for most seniors, available for more types of property interest, and
opened up a new area of financing for home purchases. This article will detail
some history and be a primer of the reverse mortgage, including a summary of
the recent legislative changes under the FHA Modernization Act.
The Home Equity Conversion Mortgage (“HECM”) reverse
mortgage is nothing new. Reverse mortgages first came to the United States in
1961 but were not federally regulated, and were not favorable to borrowers.
Congress created the HECM by passing the FHA Reverse Mortgage Legislation
(Housing and Community Development Act of 1987-S. 825) on Dec. 22, 1987. For the
first 10 years, the HECM was a pilot demonstration project limited to 2,500
Many nations have reverse mortgage programs designed to
address the problems associated with a growing elderly population unable to be
supported by a declining younger working population. There are reverse mortgage
programs in the United Kingdom, Canada, France, India, Australia, Ireland,
Spain, Japan, Germany and throughout Scandinavia.
In the United States, the public policy behind the HECM
reverse mortgage is two-fold. The first is that it is less expensive for the
government to insure a program that allows seniors to live in their homes for
the rest of their lives than it is to pay for nursing homes.1
The second is that the HECM program can be a source of income that baby boomers
can utilize to make up for the projected shortfall in Social Security revenues
beginning in 2019.2 The expectation is that the HECM reverse
mortgage will become a common retirement tool for baby boomers.
The HECM reverse mortgage is fairly straightforward. To
qualify, a borrower must be at least age 623 and own a home. There
are no credit or income requirements. The home must be the borrowers’ principal
residence. Reverse mortgages are available for single family homes,
condominiums, manufactured homes, multi-family homes up to four units and,
under the new regulations, cooperatives.4 Excluded are mobile
homes, condominiums where the senior borrower’s unit consists of 25 or more
percent of the condominium complex and structures that are on leased property
of less than 99 years (which would exclude homes in a number of retirement
All HECM applicants must have counseling from a HUD
approved not-for-profit agency. A lender is not allowed to steer seniors to
specific counseling agencies or pay for the counseling. It is paid by the
senior either at the time of the counseling or as part of the closing costs.
With a reverse mortgage, a lender makes available to a
senior a percentage of their home’s value. The percentage made available is a
function of the senior’s age and the HECM interest rate. The older the senior
and the lower the interest rate, the greater the percentage that is made
available. A 72-year-old senior will have more funds available to them than a
62-year-old senior in a house of the same value. The home value is determined
by an independent HUD licensed appraiser using a comparable value method. For
purposes of calculating the funds available, the house value is capped at the
HUD 203(b) limit now set nationally at $417,000.
With a HECM, a senior does not make monthly payments.
Instead, interest accrues on funds the senior actually uses and is paid back
only from the sale proceeds of the home in three circumstances: (i) when all
the borrowers have passed away; (ii) when all the borrowers have not lived in
the home for 12 consecutive months (if a senior borrower returns home, then the
time period for the 12 consecutive months is reset);6
and (iii) when the home is sold.
What is repaid from the sale of the home (or from other financing
sources if the heirs wish to keep the home) are the funds the senior has
actually used (which generally includes the closing costs) plus the interest
that has accrued on that amount. The remaining equity goes to the borrowers or
their heirs. If the amount owed is greater than the then house value, there is
no deficiency. HECM reverse mortgages are non-recourse loans — there is no
personal liability. In that situation, the lender will foreclose at 95 percent7
of the home value and forgive the deficiency.
The funds are available to a senior in three ways or a
combination of those ways. The first is a lump sum where they take all the
money at once to either pay off currently existing mortgages or “put it in
their pocket.” Unless used to pay off a current mortgage, the lump sum is
generally not the best idea since the interest will accrue on that whole
amount. Interest on reverse mortgages accrues on not what is made available to
the senior but on what they actually draw down.
The second is a monthly income either for as long as the
senior continues to live in the home (the “tenure” plan) or for a term of
years. The tenure plan makes sense for seniors who have certain budgetary
requirements and know how much they need each month to make up any shortfall in
their fixed income. With the tenure plan, a senior can draw down more than the
home value. The term of years plan makes sense especially where the senior
knows that they will be leaving their home at some set future date.
The third option is a line of credit. Here, a senior
draws down what they need when they need it. Interest will not accrue on the
line of credit funds since the senior has not put that money in their pocket.
Instead, the unused line of credit funds grow at a rate one half of one percent
greater than the accruing rate of interest on the funds that are drawn down.
The growth will be income tax free.8 This growth occurs
regardless of the home’s value. Even if the home depreciates below the
available line of credit funds, those funds are still available to the senior
homeowner. For example, after Hurricane Katrina, hundreds of seniors were able
to use their line of credit funds for up to 12 consecutive months after their
homes were destroyed. These seniors had the full amount of their line of credit
for use to get back on their feet although their homes had no value. They were
also not personally liable to pay back the funds used.
One interesting aspect of the HECM credit line is that
full or partial prepayment is allowed at any time. Any prepayment made will not
only pay down the reverse mortgage balance but will increase the line of credit
on a dollar for dollar basis.9 As such, some seniors
use the Line of Credit as an investment tool especially in that HECM funds are
not a countable asset for Mass Health or Medicaid spend down requirements.10
HECMs are not “too good to be true” because they are not
free. The closing costs are significant. Besides normal closing costs, a HECM
has an origination fee paid to the lender. This is now calculated at 2 percent
of the first $200,000 of the home value or lending limit, whichever is less,
and 1 percent thereafter. There is a cap of $6,000 and a floor of $2,500. A
second cost is a HUD mortgage insurance premium (MIP) set at 2 percent, again
of the home value or lending limit whichever is lower (the “maximum claim
amount”) plus an additional annual premium of 0.5 percent of the loan balance.
Borrowers do not directly pay the insurance premiums. Instead, lenders make the
payments to FHA on behalf of the borrowers and the cost of the insurance is
added to the borrower’s loan balance. That said, the closing costs on a
$400,000 home can be $16,500.
The HUD mortgage insurance fund serves two purposes: (i)
it protects lenders from suffering losses if the final loan balance exceeds the
proceeds from the sale of a home;12 and (ii) it
continues monthly payments to the homeowner if the lender fails. All HECM
lenders offer almost exactly the same terms since the federal government has
removed their risk and, in exchange, the lenders strictly follow the federal
regulations. As such, there is not a “no closing cost” HECM. Unlike traditional
mortgages, where a lender can hide closing costs in a higher interest rate, HUD
requires full disclosure. Finally, this means safety for the senior homeowners
since HUD will step in for any lender who fails. The recent failure of Indy-Mac
(the nation’s second largest HECM lender through its Financial Freedom
division) had no impact on its reverse mortgage lending. It was business as
usual for Financial Freedom all throughout the FDIC receivership.
Although a senior borrower can pay the closing costs, the
vast majority do not, meaning that interest accrues on that amount. Another
closing cost is a servicing fee calculated commonly at $35 per month.13 Interest does not accrue on the servicing
fee charge calculated from the date of closing to the senior’s 100th birthday.
This sum is escrowed and reduces the net amount available to the borrower. If
the senior permanently leaves their home before age 100, the balance is
The interest rate on a HECM is typically a variable
interest rate, although a fixed rate is available. The variable program is
either monthly or annual. The vast majority of seniors opt for the monthly
variable rate since it makes the most amount of funds available. The annual
variable rate will mean greater equity remaining at the time of the loan
termination. The interest rate is based on an index, typically the one year
treasury rate, plus a margin set by the lender. The fixed interest rate program
is rarely seen. First, the interest rate is higher.14
Next, unlike the variable programs, there is no line of credit available with
the fixed interest rate since the borrower is required to take a full lump sum
at the date of closing.15 Over the life of the loan, the
interest paid will very likely be greater than with the variable rate programs.
The final major change to the HECM program is that a
senior can now use a HECM to purchase a home. This could be a useful vehicle
for seniors who are downsizing. Previously, a senior would sell the larger home
and pay full cash for the new smaller home. Now they can use the HECM purchase
mortgage to finance a substantial part of the new home price, pay less cash
from the sale of the larger home and have no mortgage payments.16 Expect to see real estate brokers marketing
“half price” homes.
HECM reverse mortgages, like all financial tools, are
specific to the individual situation of a senior homeowner. They are one of
many options that a senior should consider as part of their financial planning.
The FHA Modernization Bill has increased the variety of options and property
counsel, financial planners, divorce attorneys, estate planners and elder law
attorneys should familiarize themselves with the program so that they can best
represent the interest of their senior clients.
16. Today, a 62-year-old selling a home for $600,000 and
purchasing a downsized $400,000 home would pay cash (assuming they did not get
a regular mortgage with attendant monthly payments) and have remaining reserves
of $200,000. With the HECM purchase, they would receive $238,472 in HECM loan
proceeds meaning cash disbursement of $161,528 with no monthly payments and a
remaining reserve of $438,472.
Robert T. Cannon is an attorney and the principal of Equitas LLC, a virtual law firm that concentrates solely in guiding seniors and lender clients through the reverse-mortgage process. Equitas currently closes reverse mortgages in 10 states and Cannon lectures nationally on the HECM reverse mortgage.