When the housing market collapsed in 2008, many reverse mortgages became underwater loans because of the substantial loss in value, putting the loan program in jeopardy. Default rates escalated in the past decade, prompting legislative changes, and creating a resurgence of consumer interest.
Recent changes in reverse mortgage policies have created better programs, which should lower default rates among borrowers. It is now possible to use a reverse mortgage as a financial tool in retirement, although it is more difficult to gain approval for the product.
What is A Reverse Mortgage?
Home Equity Conversion Mortgages, or HECMs,use the home as collateral and offer a loan which does not require repayment, as long as you remain in the house. To qualify, borrowers must be over 62 years old and have significant home equity or no mortgage. The reverse mortgage can create an income stream, without impacting your living arrangements.
Before2013, there were few qualifications needed to obtain the loan. Most seniors with a mortgage-free home or large equity holds could tap into the home equity during retirement, to make up for financial shortfalls in savings.
Today the use of reverse mortgages has expanded to include additional income strategies, making them more popular among senior borrowers. However, new restrictions make them less feasible for many struggling financially.
Recent Changes in Reverse Mortgage Lending
The Reserve Mortgage Stabilization Act of 2013, addressed rising default rates and fluctuating home values seen in recent years, leading to two significant changes implemented in 2013 through 2015. The goal was to reduce default rates among seniors who struggled to keep up with annual property taxes and insurance, required by the lenders.
The first change reduced initial lump sum payment allowed. A reverse mortgage allows youto take a lump sum payment based on the current value of the home and the life expectancy of the borrower. It is common to use this initial withdrawal to pay off the existing mortgage, eliminate other debts, or use the funds for retirement needs. The new law restricts withdrawals during the first 12 monthsat 60% of the initial principal limit. For example, if a lender offers a loan amount up to $200,000 you would have a maximum withdrawal limit of $120,000 in the first year.
The policy change ensures you have enough equity remaining to cover essential costs of home ownership, including taxes and insurance. It also means your mortgage balance must be less than this amount or you would be unable to withdraw enough to pay off the existing mortgage.
The second change is more stringent application requirements. To ensure you have enough in reserves to cover taxes and insurance going forward, borrowers must now qualify for the loan based on both financial and credit risks. If you fail to meet the underwriting requirements, the lender can decline the loan or require what is called the Life Expectancy Set Aside. This fund, managed by the lender, requiresyou to set aside a certain amount of the credit limitto cover future costs.
Analysts expect these two changes to cut default rates, due to lack of insurance and tax payments, in half. It will also disqualify many borrowers with credit or financial challenges, who might need the reverse mortgage as a life preserver, rather than a financial strategy.
More Changes Coming in 2017
Early 2017, brought more changes to the reverse mortgage industry, designed to stabilize the market.
Servicing will revert from HUD to the FHA, offering lenders guarantees on the loans backed by the federal government. If a home goes underwater and more is owed than it’s worth due to market conditions, government insurance will cover the difference, protecting borrowers and lenders in the transaction.
Lenders must inform borrowers of all available options regardless of whether the lender offers a specific program. This change will help consumers make informed decisions based on all available programs, rather than only the programs one lender provides.
The 60% withdrawal limit during the first 12 months remainsun changed and gives the FHA commissioner the ability to adjust the percentage based on market conditions, provided it remains at 50% or higher.
The current rules require lenders to sell the property at no less than 95% of its appraised value. The new ruling gives the FHA commissioner the ability to adjust that percentage based on market conditions. The new policy also loosens the ruling banning sellers from paying closing costs. Now closing costs will max out at either11% of the sales price or a set amount established by the commissioner, whichever is higher. The seller will also be able to pay closing costs customarily paid for by a seller, simplifying the sales process for the lender.WHAT?The latest policy updates take effect on September 19, 2017.
What These Changes Mean to Borrowers
Stabilizing the reserve mortgage could lead to major banks adopting programs to offer the loan. Competitive market conditions could lower the cost of theloan, which currently comes with very high fees.
New protections may lower the available equity limits offered by lenders, but secure home owners theability to maintain the property and reduce default risk. Additional protections offered to non-borrowing spouses could allow them to remain in the home after the death of the borrower.
The downside is increased underwriting, similar to traditional mortgages, which could disqualify potential borrowers with spotty credit or limited financial reserves.
Using a reverse mortgage to eliminate the current balance on the home can improve cash flow in retirement. It can also be used to create income in down markets, or bridge cash flow gaps allowing you to delay social security, increasing the monthly payout for your lifetime.
Using the funds for other purposes such as paying off credit card debt, vacations or cars, could leave borrowers with few financial reserves to cover ongoing financial needs in retirement. It is possible to use a reserve mortgage as a tool to a stronger financial position in retirement when you have fewer resources than you planned.