Wednesday, September 22, 2010

Reverse Mortgages - The What's and Why's

Reverse Mortgage - a mortgage that goes backwards? In a real sense YES! Instead of building equity by paying back what you owe, a lender determines how much equity you have in your home and gives you cash for a part of that equity. BUT each month that passes you lose a month's worth of equity. It truly is a mortgage in reverse. The key is that you do not pay it back. BEWARE! NOTHING IS FREE!

In exchange for taking a payment for part of the equity in your house, you give the lender the right to own you house at the time of your death, or at such other time as you no longer live there (think assisted living etc.). Having a second home is fine. Living 6 months in your primary home, the one with the reverse mortgage, and 6 months in some far away place, is okay. It is only when you move out for good that the lender can take your house and sell it. The idea is that the Lender will have calculated accurately enough to be able to sell the house and get all of the money it "loaned" to you back, along with interest.

1. The amount of the loan is based on the value of the house minus any loans and other liens against it at the time of the transaction, or more succinctly, the EQUITY. That's it? Just call and get money? Well almost but the "devil is in the details" (that expression should be the topic of its own posting).

2. You or your spouse/partner/whoever owns the house jointly with you, must be at least 62 years old. Why? Because that was they rule that was made, and it's a rule that the Federal Housing Administration (FHA) has dictated. The theory is that at 62 you may be near retirement, there is a greater likelihood of serious illness, etc - basically income may drop more frequently than in the younger population. The older you are, the higher the percentage of equity you get. Why? Because you will die sooner (at least that's the way it works on paper).

3. The lender in a Reverse Mortgage acts more like a life insurance company. The Lender takes the age of the borrower and looks up the life expectancy to estimate "how soon will the old bugger die"! Obviously, the sooner the lender gets the house back the faster it can be sold, and the more the lender makes.

This is where it gets complicated. Why does a lender make more? When the loan is made, the lender considers how soon the person will die or move, and therefore determines how much to pay. Remember, interest builds each month.

The other element is the "time value of money". For example: If I lend you $100,000 and you give me a mortgage on your house, which is worth $166,666, and make no payments to me by agreement, but the interest is just accruing, or accumulating waiting to be paid, I have to take into account the interest I could be getting on my money if I bought bonds where I get interest every month.

Let's say that I assume you will live, per the "tables", another 12 years and that for those 12 years, I would earn an average of 6.333% per year with the bonds. I can do some math and figure out how much I need to get back at the end of the REVERSE MORTGAGE to be sure I get back at least what I loaned to you, ($100,000) and the amount I would have earned if I had bought those bonds in the example, instead of loaning you the money - $75,996, for a total of $175,996. If the house sells for at least this much I get all of my money and its earnings back. If it sells for less, I lose profit.

In theory, if you were to die after 3 years, and I sold the house for the $166,666 it was worth at the time of the mortgage, I make a large profit. THERE IS A BUILT-IN SAFEGUARD. A family member can always pay me back what I loaned PLUS the interest that was deferred - earned by me but not collected. If the payback is less than the house is worth, then the family would want to pay off the mortgage.

4. The program is regulated by the FHA and they also insure it. The insurance protects the borrower in case the borrower is getting monthly payments (instead of taking a lump sum at the time of the closing) and the Lender goes out of business; FHA pays the monthly payments for the duration. There is a hefty fee for the insurance that gets paid to FHA at the time the mortgage is closed (put into effect), but it's well worth the cost to know that you will get paid.

5. Let's say that in the above example the homeowner lives 10 years longer than expected and the house goes down in value. The lender in this situation takes a big loss. BUT that loss is NOT a debt of the homeowner's estate. The lender takes the loss. NEITHER YOUR CHILDREN NOR ANYONE ELSE has to pay anything to the lender.

REVERSE MORTGAGES SOUND GREAT BUT THEY ARE NOT FOR EVERYONE! There is a mandatory counseling session with a trained financial expert who will explain the reverse mortgage concept and apply it to the prospective borrower's situation. Further, the fees that the broker can take are regulated/set by FHA.

A Reverse Mortgage can make life easier for someone who has equity in his/her home, a mortgage payment that is preventing the person from retiring, or worse, causing a foreclosure due to lower income at retirement, by lending a big portion of the home's equity to the homeowner. There are NO monthly payments. There is no credit check. It is all by formula; Amount of equity, the homeowner's/borrower's age ( minimum of 62) and then the amount of the maximum reverse mortgage payment can be calculated. If it's enough to payoff the exising mortgage you get to live in your home without making another mortgage payment, and if there's enough so that money is left over, it can be paid to you in a lump sum or in monthly installment.

Who would have thought: a mortgage that pays you!

Author's Copyright by Richard I. Isacoff, Esq., Septmeber, 2010

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