We’ve been told that asset-based mortgage lending, wherein the loan depends solely on the value of the underlying real estate collateral, is a dead concept, at least for homeowners. The idea, in its purest form, ignores virtually all aspects of borrower qualifications, such as credit, income and liquidity.
But there are a lot of these loans being made every day. There are only two criteria to be considered for one: You have to be 62 years old, and own your home. And, as has always been the case with this kind of lending, have a lot of equity in your property.
For mortgage mavens, these are FHA insured loans, called Home Equity Conversion Mortgages, or “reverse mortgages” to the rest of us.
The concept is simple. It enables elderly borrowers to stay in their home and take some of the equity out in cash. They’re not compelled to sell the property to get some liquidity. Eligible homeowners can get a loan up to around 60 percent of the property’s current value. All of the cash, after paying off any existing liens plus closing cost goes to the borrower, either in a lump sum or over time, whichever the homeowner elects.
There are two key features to the program: First, the borrower never makes a monthly payment on the loan, although it can be paid off at any time without penalty. And, second, the loan is without recourse, which means that the borrowers or their heirs can never be pursued for any payment or liability. The lender can be made whole only when the property is sold. If the sales price doesn’t cover the loan, then the FHA steps in to make up the difference.
The fact that there are no more payments for the life of the borrowers actually motivates some homeowners to secure a reverse mortgage with little equity, just to pay off their existing loan and be free of house payments.
The reverse mortgage is a negative amortization loan. Obviously, if the borrower makes no loan payments, something has to be done with the interest; it’s added on to the loan. This obviously affects the remaining equity when the borrowers die or move out of the property, although, in normal times, the property will most likely appreciate in value.
But, the purpose of the program is to permit older homeowners to stay in their home, and at the same time use their often considerable equity at a time when they can benefit from it. In the right circumstances, it can serve that purpose very well.
One reason that this product is often eyed with suspicion is that, prior to the FHA entering the picture, there was a burst of private lenders selling different programs, some of which weren’t at all borrower friendly. To obviate this, AARP and the National Council on Aging worked with HUD to design a loan with features designed to benefit and inform prospective borrowers. Most who secure these loans will agree that the Feds might have overdone it on the information side. There’s such a volume of disclosures that much of it becomes less than comprehensible.
The loan definitely isn’t for everyone over 62. The ideal borrowers might be in their mid-70s with a lot of equity but limited cash. Living to be 105 might not leave a lot at the end, and maybe FHA might have to cover a shortfall, but nobody, not the borrowers or their heirs, will ever be tagged with any deficiency.
One little known element of the HECM is that unused funds can increase at a pretty attractive rate to the benefit to the borrowers or their heirs. Here’s how it works. Say that the property is worth $100,000 when a $60,000 reverse mortgage is secured. The loan balance becomes a line of credit for the borrower that can be drawn on, but need not be. This unused line increases at a rate equal to the current note rate, plus the FHA mortgage insurance. If the loan is adjustable, tied to LIBOR, then the rate might be, say, 2.75 percent, with the mortgage insurance premium at 1.25 percent, for a 4.00 percent total. That unused $60,000 compounds at 4.00 percent per year, effectively increasing the available line. Many reverse mortgage borrowers use this as a form of an annuity to be distributed at an appropriate time in the future among heirs.
Finally, the borrowers must live in the home. When they cease to do so on a full-time basis, the loan must be paid off. The personal representatives of the homeowners can refinance the property if they want to continue owning it, or put it up for sale if they don’t.
The scam of choice in connection with reverse mortgages is the oldie but goodie, occupancy fraud. Either the borrowers will attempt to represent the investment property in, say, Denver as their primary home, and the one in Scottsdale as a second home, visited only occasionally. Or the borrower passes on and the heirs claim that Dad or Mom really isn’t dead, but still happily residing in the homestead.
In one instance, told as a true story, the lender was pretty certain that Mom, in fact, was no longer in residence. Her son averred that she most certainly was, “In the urn, right above the fireplace.”
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
The purpose of the program is to permit older homeowners to stay in their home, and at the same time use their often considerable equity at a time when they can benefit from it.