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How to Reverse Reverse Mortgage Exits


Alicia Munnell, the director of the Center for Retirement Research at Boston College, is a weekly contributor to “Encore.”

Bad news for retirees.  The two biggest players in reverse mortgages exited the business.  Bank of America (#2) quit in February and Wells Fargo (#1) in June.

Reverse mortgages enable people 62 and over to tap their home equity.  And despite the bursting of the housing bubble, the house is a crucial component of most households’ assets (see figure below).  Accessing this equity will become increasingly important in a world where retirement needs are increasing – people are living longer and face rapidly rising health care costs – and the retirement system is contracting – Social Security replacement rates are declining under current law and employer-provided pensions have shifted from defined benefit plans to 401(k)s with modest balances.

Reverse mortgages allow households to remain in their home, take out a loan, and pay off the loan plus accumulated interest when they die, move out, or sell the house.  The loan can be taken as a lump sum, line of credit, lifetime income, or as a payment for a specified period.  To date, the line of credit has been the most popular option.  The borrower  remains responsible for paying property tax and homeowner’s insurance.

The most widely used reverse mortgage is the Home Equity Conversion Mortgage (HECM),  which is insured by the Department of Housing and Urban Development (HUD).  HUD offered the HECM Standard in 1989 and in 2010 issued the HECM Saver, which sharply cut the fees and somewhat reduced the size of the potential loan.  Loans are available on values up to the Federal Housing Administration (FHA) limit of $625,500.

The amount available to a homeowner through a reverse mortgage depends on three factors:

  • Home value: the more valuable the home, the larger the loan.
  • Interest rate: the higher the interest rate, the more rapidly the outstanding balance will increase, so the smaller the loan as a proportion of the value of the house.
  • Age of borrower: the older the borrower, the less time for interest to accrue, so the larger the loan.

Reverse mortgages have been criticized as being too expensive with high upfront fees; the HECM Saver attempts to address this concern.  Reverse mortgages have also received bad publicity regarding aggressive salesmen persuading elderly borrowers to invest their proceeds in inappropriate products.  Despite these issues, reverse mortgages are a product that more and more households will need.

Unfortunately, reverse mortgages are not a profitable line of business in a world of recession and declining home prices.  The recession makes it difficult for many borrowers to keep up with required property tax and mortgage insurance payments, which can lead to technical defaults.  No bank wants to be forced to foreclose on a vulnerable elderly homeowner.  Declining home prices mean that lenders soon see a crossover point where the loan is bigger than the value of the house, and it also means that fewer homeowners qualify for loans.

We need some creative thinking to design a better mousetrap that will enable retirees to tap the equity in their home.  They are going to need the money.

For more: How to Evaluate a Reverse Mortgage


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    • All reverse mortgages which are currently available are first and foremost nonrecourse mortgages by law. A HECM is a special category of reverse mortgage which is available to seniors 62 and older and is, as stated in the article, insured by a division of HUD, FHA. Because HECMs are the dominant reverse mortgage product being offered in the market today, the rest of this comment focuses entirely on HECMs.

      The HECM has features which are unique in the mortgage industry and can be very beneficial for most borrowers. For example, the line of credit is guaranteed by FHA and cannot be reduced or frozen by a lender simply because the value of the home has dropped. By formula the proceeds available to borrowers can grow based on the amount of available proceeds in the line of credit. (It should be pointed out that lines of credit are not currently available for a fixed rate HECM and all fixed rate HECMs require that available proceeds be taken at the time of loan funding which may not be the right decision for all borrowers.)

      Like all true nonrecourse debt, lenders cannot obtain a deficiency judgment against the borrower, estate, trust, or heirs. Generally the loan becomes due and payable as a result of death, sale of the home, or change in the principal residence of the last borrower living in the home.

      Here are some things to be aware of. If any portion of the debt is forgiven at loan termination through foreclosure, deed in lieu of short pay, foreclosure, short sale, or other title transfer, income tax liability can arise as a result. Generally this occurs when the balance due on the debt at loan termination is greater than 95% of the value of the home also at the time of termination. Borrowers will generally see much less of an income tax bite than estates, trusts, or heirs due to the income tax provision which makes homeowners eligible to exclude specified amounts (or portions thereof) of gain from the sale of a qualifying principal residence.

      Here is a large potential income tax benefit. The deductible portion of accrued interest generally becomes deductible when paid. The accrued interest is also considered paid as a result of refinancing or payment in full (even when a portion of the debt is forgiven as long as the amount forgiven is recognized as additional proceeds in a taxable transfer such as foreclosure). The rules related to the amount of interest which is eligible for deduction are no different than those governing other mortgages. Since deductibility is based on use of proceeds, borrowers need to document how proceeds are used for income tax purposes. Since estates, trusts, and heirs may be eligible to deduct all or a portion of the interest which accrued but was unpaid at the time of the death of the decedent, such interest will be eligible for deduction when paid; however, the amount of deduction is generally the amount which the decedent could have deducted if the decedent were living at the time of payment.

      The tax rules are generally complicated so it is advised as part of the borrowing process that borrowers should seek the advice of those income tax professionals who are experienced, competent, and knowledgeable about reverse mortgages. Planning the payment of accrued interest can greatly reduce tax liabilities in years of unusually high taxable income. Since payment application rules apply to how much of a partial payment of the reverse mortgage is treated as paying accrued interest, be sure your income adviser is reasonably experienced with reverse mortgages; it is best not to be the test case.

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    • Reverse Mortgages remain a viable option for seniors! As I posted in my blog, “We are not Chicken Littles – the sky is not falling on the reverse mortgage world.”

      The decision by Wells Fargo and Bank of America to leave reverse mortgages was business decisions on their part – not a reflection on the reverse mortgage industry as a whole.

      There are other lenders who offer and service reverse mortgages, some of whom only offer and specialize in reverse mortgages. The support and confidence in reverse mortgages remains strong among them and those of us in the industry.

About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.