A reverse mortgage is a loan against a home’s equity that requires no monthly payments, and is available to homeowners 62 and older. The loan proceeds can be taken as a lump sum, as monthly income for life, or as a line of credit. Interest on the borrowed money is added to the loan amount, which doesn’t have to be paid off until the borrower dies or no longer uses the home as their primary residence. As long as the borrower continues to pay their property taxes, homeowners’ insurance and maintenance, the lender cannot demand repayment of the loan. The lender can never look to recover more than the home generates in a sale, even if the loan amount exceeds the sales proceeds, thereby protecting the borrower’s other assets.
The only reverse mortgage insured by the US federal government is called a Home Equity Conversion Mortgage, or HECM, and is only available through a lender approved by the Federal Housing Administration, or FHA. The FHA is a government agency that provides mortgage insurance on loans made by FHA-approved lenders. The FHA is overseen by the Department of Housing and Urban Development (“HUD”).
To protect reverse mortgage lenders against potential losses, the federal government limits the initial loan amount, and maintains an insurance fund with premiums paid by borrowers. The FHA has recently taken action to strengthen the insurance fund.
New rules that took effect in October 2017 will raise upfront costs for some reverse mortgage borrowers, and will reduce the available maximum loan amounts for most. So, is a reverse mortgage still an attractive option?
As of October 2nd, the maximum loan amount, called the Principal Limit Factor (“PLF”), was reduced, so that a homeowner who previously might have been allowed to borrow 60% or 70% of their home’s value, will now get something less. The exact amount will vary by borrower, because loan limits are based on the applicant’s age and interest rates, as well as the property’s value.
In addition, the FHA previously charged an upfront insurance premium of 0.5% to borrowers who took less than 60% of the maximum loan amount, and 2.5% to those who took more than 60%. The new insurance premium will be 2% for all borrowers.
The aforementioned changes may make a reverse mortgage less attractive for many prospective borrowers. However, an additional change is positive – HUD reduced another separate, annual insurance premium from 1.5% of the debt to 0.5%. Because the premium is generally added to the debt outstanding, the reduction in the premium means that the borrower’s debt grows more slowly, potentially leaving more equity available to the borrower or heirs when the home is sold.
The insurance premium increase is intended to boost the FHA insurance fund, while the reduction of the PLF is designed to limit losses by slowing the growth rate of loan balances.
While HUD and the FHA haven’t said how the changes will affect borrowers in different categories, some experts expect the average borrower will now only be able to access 58% of a home’s equity, down from 64%. And the new standards are likely to affect younger borrowers the most, because their loans carry the greatest risk of growing larger than the property value.
Finally, market observers generally agree that the popular strategy of creating a reverse mortgage line of credit – also known as a stand-by reverse mortgage – is likely to be less useful, because credit lines will now grow more slowly. The “stand-by” involves taking the loan as a line of credit at a relatively young age, accessing it in emergencies or when other retirement assets – like stocks – are down in value, and converting the unused, available credit to monthly income years later. The credit line grows at the loan rate plus the annual insurance premium, and with the premium now at 0.5% instead of 1.25%, the line will grow more slowly.
As a result, it is anticipated that borrowers are now more likely to wait to obtain a reverse mortgage until they actually need it.