The reverse mortgage has matured.
These loans, which allow seniors to spend their home equity without selling their home, have historically been cumbersome and expensive. But new options now empower seniors to tap smaller amounts of equity in a more affordable way, according to Peter Bell, president of the National Reverse Mortgage Lenders Association, a group in Washington, D.C., that represents lenders and investors in the reverse mortgage business.
"Some changes from the market, from the regulatory side and in the counseling, have really improved the value proposition for a lot of seniors from what has been the traditional perception of reverse mortgages," he says.
Cheaper Mortgage Insurance
The biggest change is the introduction of a new reverse mortgage, called the Home Equity Conversion Mortgage Saver option, or HECM Saver. It has a cheaper upfront mortgage insurance premium, or MIP, compared with the traditional HECM reverse mortgage, now known as the standard option.
Mortgage insurance protects lenders from loan losses, though borrowers pay the cost. Most reverse mortgages are insured through the Federal Housing Administration, or FHA, a division of the Department of Housing and Urban Development.
The trade-off, due to the lower MIP and other program changes, is a 10 percent to 18 percent reduction in the maximum loan amount allowed on the saver option, and 1 percent to 5 percent on the standard option, depending on the borrower's age and interest rate, Bell says. The lower loan amount allowed on the saver option means the FHA's risk exposure is lessened.
"In exchange for taking less money, the borrower gets to pay a 0.01 percent upfront MIP instead of a 2 percent upfront MIP," he says.
The upfront MIP is based on the value of the house, not the loan amount. But still, the savings are clear. On a home worth, say, $250,000, the upfront MIP on the saver option would be just $25, while the upfront MIP on the standard option would be $5,000. That's a saving of $4,975.
Borrowers also pay an annual MIP of 1.25 percent of the outstanding loan balance on either the saver or standard option.
Lower Origination Fees
Another change is that many lenders have reduced or eliminated their origination fees on reverse mortgages, according to Barbara Stucki, vice president of home equity initiatives at the National Council on Aging, a nonprofit service and advocacy group for older Americans, based in Washington, D.C. The maximum loan origination fee was capped by law at $6,000 several years ago, but lower fees are now commonplace.
"Some banks charge no origination fee or a reduced origination fee, and some may charge little or nothing in the way of servicing fees," Stucki explains.
That could mean savings for borrowers, but it also means borrowers must shop around as the fees are no longer standardized. A low fee could be offset by a higher interest rate.
Lower Interest Rate
A third recent change is that lenders can now use a minimum expected interest rate of 5 percent, instead of 5.5 percent, to calculate the maximum loan amount, Bell says. That lower rate means homeowners can borrow more money at a lower cost.
Borrowers may be tempted by the fixed-rate option, but Susanna Montezemolo, vice president of federal affairs at the Center for Responsible Lending in Washington, D.C., says the adjustable rate may be a smarter choice because the fixed rate requires that the borrower tap the full amount of equity upfront.
"For the majority of people, it makes more sense to take out a minimum amount upfront and then have access to that line of credit, because they will owe less in interest over time," she says.
The revamped reverse mortgage is an improvement, but it's still a loan against the value of a house. The borrower gets a lump sum, line of credit, stream of monthly term payments or combination of those choices, but the mortgage loan still accrues interest, and one day, the principal and interest must be paid off.
"It's very important that people understand they aren't getting rid of their mortgage. They are deferring the payments, and the payments are accumulating over time, and they are paying interest on the deferred payments," Stucki says. "It's like putting a spigot on your equity and it's draining out, and you are paying for the privilege of liquidity."
The maximum loan amount today is $625,000, but that could change if Congress decides to lower national loan limits.
Counseling, either in person or on the telephone, is required for all reverse mortgage borrowers. Counseling sessions are private and personalized to the borrower's situation.
The borrower must now demonstrate an understanding of the information before the counselor will issue a completion certificate, says Bell.
Some nonprofit agencies offer reverse mortgage counseling free or at a nominal fee. The going rate is about $125.
"Even if they have to pay, it's probably a good investment," Stucki says. "They could be locking up their home equity and potentially draining out that equity at an alarming rate if they get the wrong product or make a wrong decision."