With or without their advisors' help, a growing number of older investors plan to use what is often one of their largest remaining assets-the equity in their homes-to finance their long-term care or, in some cases, their purchase of long-term care insurance.
Already, one of Reston, Va.-based planner Judy Redpath's clients has told her just that. "She's let me know that she's going to use her home equity for long-term care," says Redpath. "It's her choice. It's an intriguing concept. I just want to make sure my clients understand all the implications."
Once viewed as a dangerous and dubious strategy, the reverse mortgage is one that more seniors whose primary asset is their residence are tapping to finance various retirement needs. Redpath is not alone in facing increased client interest in reverse mortgages. A growing number of individuals have begun to inquire about the possible use of reverse mortgages-that once much-maligned loan product that seemed to target and dupe a segment of society that can be in the greatest financial need: seniors.
Luckily for advisors, the Wild West days of reverse mortgages are coming to an end, thanks in large part to the fact that the Federal Housing Administration (FHA) and the Federal National Mortgage Association (Fannie Mae) have gotten into the industry. Their entrance has done wonders to lower interest rates and closing costs and standardize features of reverse mortgages, which in turn has encouraged national lenders such as Financial Freedom (Lehman Brothers' reverse-mortgage arm) and Wells Fargo to offer increasingly competitive products.
Because there is still a good deal of controversy over what a reverse mortgage is or isn't, it's best to start with the facts. It's the reverse of a traditional mortgage in that it is a "rising debt, falling equity" deal designed for borrowers who want to spend down the equity in their homes while they live there without having to make monthly repayments. Reverse mortgages typically require no repayment for as long as you-or any co-owner-live in your home. They differ from traditional loans in these ways:
You don't need an income to qualify for a reverse mortgage.
You don't have to make monthly repayments-ever.
You can't owe more than your home's value, regardless of how long you live.
Reverse mortgages are "no recourse," meaning a lender can't attach other assets, even after a borrower's death.
Instead, the amount the borrower owes grows larger over time. As the debt grows larger, the amount of equity a borrower would have left after selling his or her home and paying off the loan shrinks. You cannot, however, owe more than your home's value at the time the loan is repaid.
Anyone 62 or older who has equity in his or her home is eligible for a reverse mortgage, though the average age of borrowers is 77, says Paul Franklin, co-owner of Franklin Funding in Charleston, S.C., a reverse-mortgage originator that is approved by both FHA and Fannie Mae.
Franklin says it's important for planners and anyone working with seniors to get to know the lenders in their area who specialize in reverse mortgages. "Any good lender should run a spreadsheet that shows FHA and Fannie Mae offerings and at least one private product," he says. Franklin also offers the Financial Freedom reverse mortgage, which unlike the FHA and Fannie Mae reverse mortgages, does not have a loan cap. While their interest and fees are more expensive, proprietary loans can provide a client who has a high equity balance with more funds.
Keep in mind that rates on reverse mortgages are adjustable and readjust monthly, though for a higher rate, some products allow borrowers to lock in their rates annually. The older the borrowers, the more funds to which they're entitled. While a reverse mortgage continues to accrue interest as long as the loan is outstanding, a borrower can pay off his or her balance at any time. The loan must be paid off when the home is sold or an estate is settled. All the lenders mentioned in this article send borrowers monthly statements that show the payoff amount. They require, however, that any existing home-equity loan a borrower has be paid off at the time the reverse-mortgage proceeds are paid.
Borrowers or their heirs are entitled to any equity that remains once the loan is paid. For instance, if a borrower takes out a reverse mortgage of $120,000 on a $300,000 house and decides five years later to sell the house and move to Florida, he or she needs only to pay off the balance (closing costs are almost always added) and interest. The borrower keeps the remaining sales proceeds.
Considering all of a client's options is crucial, but it's also important to be realistic. For instance, home-equity loans or lines of credit often are touted as cheaper alternatives to reverse mortgages. While the tab for closing costs may be less, many seniors won't qualify for home-equity loans because they have little or no regular income. And with an apples-to-apples comparison of rates, planners may well find that FHA and Fannie Mae loans are a good deal less expensive. Selling a home also may be an option to unlock home equity without having to pay interest, but it's important to consider what capital-gains tax the client will incur. Clients' comfort level and wishes should dictate actions whenever financially feasible. Some people want to stay put in their homes, even if it is more expensive.
While some planners are in denial about clients' possible need or intended use of a reverse mortgage, Franklin sees the full gamut of clients come to his firm: "We just closed a case for a woman in her eighties who needed a reverse mortgage to pay the $600 or $700 in prescriptions she needs monthly to treat her Parkinson's disease."
In contrast to the clients he sees who are in dire financial straits-typically female widows in their late seventies-Franklin also is working with a new breed of seniors, those who want to tap home equity to buy luxuries. "These are folks who are living in million-dollar homes who want to enjoy life even more by going on cruises and buying new cars. They do it by tapping an asset they believe is not contributing to their quality of life-their home," he says. These types of reverse-mortgage applicants are younger-often in their late sixties or early seventies-and may already have LTC insurance, says Franklin, a CFP licensee.
How does he know so much? For the past 12 years, he's co-owned with his wife, Barbara, an insurance agency that specializes in long-term care insurance.
"For those who can't afford long-term care insurance, a reverse mortgage can be an attractive alternative," Barbara Franklin says. "If someone gets sick enough, they may not be eligible for insurance anyway, so this is an option."
To find out more, planners across the country are starting to kick the tires of reverse mortgages. The Washington, D.C., chapter of the Financial Planning Association recruited Stephen Moses, president and founder of the Center for Long-term Care Financing, Seattle, to be their guest speaker late last year. Norma Severns, who is president-elect of the D.C.-area FPA chapter and a principal of Armstrong MacIntyre & Severns in Washington, says the topic of reverse mortgages has become a more pressing one. "We haven't used the product yet," she says, "but my expectation is that I have some clients whose retirement projections are marginal. If they truly live longer lives, then they are really likely candidates for reverse mortgages," says Severns. "I'd see this, if necessary, as an emergency resource to fund final years. I'll keep it in my hip pocket."
In some instances, especially with clients who could get hit with a capital-gains tax approaching 30% if they sell their property, a reverse mortgage could make sense as a "late-stage planning tool," Severns says.
Moses says reverse mortgages also can be useful if clients are unsuccessfully looking for funds to buy long-term care insurance. The move can help preserve a senior's estate and also provide either in-home or institutional long-term care if the client needs it. "Reverse mortgages got a lot of bad publicity, and there are still questionable products out there, but there are very good products as well, and it's getting easier to find them," he says.
The Fannie Mae and FHA-insured reverse mortgages offer borrowers three options for taking their money. They can take it in the form of a lump sum, put money aside in a line of credit (on which they earn interest in a cash-value account) or take the funds in the form of a monthly annuity payment. Proprietary products, such as Lehman's Financial Freedom, do not offer the annuity option.
Usually, says Paul Franklin, clients tap their reverse mortgage in a combination of ways. Maybe they need a lump sum to pay bills, do home repairs or take a trip, but they then also maintain a line of credit or annuitize the rest of their payments.
"What's important is that clients are able to use an asset they may desperately need or want to use," Franklin says.
Go To The Source
For a list of FHA- and Fannie Mae-approved lenders in your area, click on www.reversemortgage.org. For an excellent primer you can share with clients, check out the AARP's Web site on reverse mortgages (www.rmaarp.org). You also can find free, expert reverse-mortgage counseling for a client or family members by calling the federal Housing and Urban Development Department at (888) 466-3487, (800) 569-4287 or (800) 217-6970.