The Wall Street Journal
By: Kelly Greene
June 25, 2011
If someone in your family is planning to apply for a reverse mortgage to pay for long-term care or other expenses, they should move quickly: Two of the largest lenders are exiting the business, and a popular federal incentive geared toward borrowers could end soon.
Then again, some families can afford to set up their own reverse mortgages without bothering with banks.
Reverse mortgages allow people who are 62 or older to convert their home equity to cash--either through a lump sum, a line of credit or monthly payments. The loan is due, with interest, when the borrower dies, moves, sells the house or fails to pay property taxes or homeowners' insurance. Heirs often sell the house, pay off the loan and keep the balance.
Wells Fargo & Co. recently announced that it would quit accepting applications for such loans after June 30, citing "unpredictable home values" along with restrictions that make it difficult to determine older adults' abilities to continue paying property taxes and homeowners' insurance.
Bank of America Corp. left the business in February, citing the need to reassign employees to loan-modification work. In addition, says spokesman Terry Francisco, "the prolonged housing downturn and regulatory uncertainty regarding seniors who weren't paying their property taxes and insurance affected our view."
In the fiscal year that ended Sept. 30, lenders made 79,070 "home-equity conversion mortgages," or reverse mortgages insured by the Federal Housing Administration, down 31% from the previous fiscal year. FHA-insured reverse mortgages make up the bulk of the market.
But families with well-off adult children have tended to avoid reverse mortgages, in part due to the costs. The upfront fees can total as much as 5% of a home's value. As part of the upfront costs, borrowers are required to pay a mortgage-insurance premium ranging from 0.1% for loans with a lower equity payout to 2% for those with a higher payout.
To reduce fees, streamline paperwork and increase the equity a parent could tap, an adult child could either buy a parent's house outright or set up a private reverse mortgage.
If multiple children are involved and the parents own a house worth considerably more than they paid for it, the family could set up a private reverse mortgage using a limited partnership. That way, the children could benefit from a "stepped-up basis" when the parents die, meaning the children wouldn't owe capital-gains tax when they sell, says Robert Siefert, a financial planner at Modera Wealth Management LLC in Boston.
Another option is to have the adult child set up a revolving line of credit for the parents backed by their home equity. For a few thousand dollars in legal fees, you can do it using a promissory note, a deed of trust recorded at a local courthouse and a revolving credit agreement, says Kenneth Kossoff, an estate lawyer in Westlake Village, Calif.
There are risks: The child funding a reverse mortgage could fall on tough times and stop paying. Or the parents' house could fall in value, leaving the children holding an asset worth less than they have lent against it, Mr. Kossoff says. But family lenders also "may be able to more closely watch to see if the parents are paying for insurance, taxes and upkeep," he says.
For families who prefer go the traditional route, enough commercial lenders remain, for now, to service the reverse-mortgage market. And borrowers should still be able to find discounts on origination fees.
What is more worrisome in the short run is that a big incentive could end after September: The limit on the maximum amount of equity that lenders can use to determine the amount that borrowers can extract from their homes using federally insured reverse mortgages is set to fall to $417,000 from $625,500, unless Congress or the Department of Housing and Urban Development extends the higher limit. Also on the chopping block is federal funding for the counseling required to take out an FHA-backed reverse mortgage.
Applications for reverse mortgages could soon get more complicated, too: Borrowers may be required to provide additional information so lenders can assess whether they need to set aside funds to cover taxes and insurance.
"The good advice is to do it this summer," says Barbara Stucki, vice president for home-equity initiatives at the National Council on Aging, a Washington-based advocacy group.
Before the recession, borrowers sometimes could refinance a reverse mortgage years later to tap additional equity resulting from rising home values. But now, municipalities are raising property-tax rates at the same time house values are falling. Meanwhile, homeowners' insurance premiums have increased substantially in states prone to hurricanes and flooding.
Recognizing the rising number of delinquencies, HUD has asked lenders to set up a "realistic" repayment plan for borrowers falling behind. They also can get free counseling.
Like conventional mortgages, reverse mortgages come in two basic forms: fixed rate and adjustable rate. But with reverse mortgages, borrowers using fixed-rate loans are required to take a lump-sum payment--meaning you have to start paying interest on the entire amount available to you right away, says Lyn Link, a former reverse-mortgage broker in Joplin, Mo., who operates an informational website called Reverse Mortgage Critic.
Taking out a lump sum makes sense if you are using the money to pay off a big bill--but if you aren't going to use the money immediately, you could lose out over time.
"If borrowers put that money in the bank and it's making 1%, but it's costing 6% in the interest rate, every year they're losing 5%," Mr. Link says.
Interest rates for adjustable-rate reverse mortgages typically fall between 2% and 3% right now; those for fixed-rate loans are more than 5%, says Peter Bell, chief executive of the National Reverse Mortgage Lenders Association, a trade group.
With tax and insurance costs rising--and property-tax breaks for older adults being cut in some places--it is a good idea to establish a cash stash to make sure those bills are paid. Ms. Stucki suggests setting aside two years' worth of payments in a separate savings account.
Write to Kelly Greene at firstname.lastname@example.org