Many older adults could benefit by using this little-known, non-traditional mortgage product.
BY J. D. DINNOCENZO, MBA, CSA, CMP

Tom and Mary were thrilled to be moving to Florida to begin their retirement. They found the perfect home on a beautiful golf course and

were excited about starting a new chapter in their lives. After applying for a mortgage, they were devastated when they received the phone call from their loan officer advising them their loan had been denied. Unfortunately, this scenario is all too common.

One of the biggest challenges that older adults face today when purchasing a home is that they typically do not qualify for a traditional mortgage. The primary reason for this is that their retirement income is not sufficient to meet the rigid debt-to-income guidelines set forth by Fannie Mae and Freddie Mac. So, they’re forced to buy less home than they would like and/or use a substantial amount of cash reserves to purchase the home, or even possibly lose hope of being able to move at all. Fortunately, there’s a solution.

Home Equity Conversion Mortgages

The Home Equity Conversion Mortgage or HECM (also known as a reverse mortgage) is often an ideal solution to help older adults purchase a home using a non-traditional mortgage product. Although the HECM mortgage has been around since 1987, it wasn’t until 2009 that the Department of Housing and Urban Development (HUD) approved the use of a reverse mortgage for home purchase transactions.

So, how does a reverse mortgage work when buying- ing a home? In a HECM for a purchase transaction, the buyer brings an equity contribution to the closing in the form of a down payment. The down payment is about 50 percent of the purchase price and the balance of the purchase is financed using a reverse mortgage. To better understand how the transaction works, let’s look at an example: a buyer is purchasing a home for $400,000. The home buyer would secure a reverse mortgage for $200,000 and bring the other $200,000 to closing to cover the down payment and closing costs and ends up with a mortgage that has no monthly payment — it’s that simple!

The actual loan amount may be higher or lower depending on the borrower’s age, home value, and current interest rate. Although the amount of the down payment may seem high compared to the usual 20 percent down payment in a traditional mortgage, home buyers using a HECM to purchase a home typically are selling a home that is either paid off or has a significant amount of equity, so a large down payment is not an issue.

Right-Sizing and Dream Home Strategies

There are two primary strategies where a HECM for purchase can be utilized: the right-sizing strategy, and the dream home strategy.

The right-sizing strategy is typically where homeowners are downsizing from the large family home where they raised their children and want to purchase a home that better suits their current needs, such as a single-story home with less maintenance or a home in a warmer climate.

Tom and Mary decided to sell their large home in New York and move to Florida where it doesn’t snow. Their New York home is worth $625,000 and they have no mortgage. Tom and Mary sell their home for $625,000 and net $600,000 after real estate fees. They find the perfect home in sunny Florida valued at $400,000. Tom and Mary could easily pay cash for their new home, but instead, they decide to utilize a HECM for purchase mortgage of $200,000 and bring $200,000 cash from the sale of their New York home. This right-sizing strategy allows Tom and Mary to move into the perfect home while putting $400,000 into their savings to help fund their retirement.

In the dream home strategy, Tom and Mary have the same $600,000 to invest in their new home, only this time they find their dream home on a golf course and it costs $800,000. Again, they take advantage of the HECM for purchase and buy their dream home. They utilize a HECM loan for $400,000 along with $400,000 from their available funds to buy the house and still have $200,000 leftover to put away for their retirement.

In both strategies, Tom and Mary have moved into a new home that better suits their needs and even saved some money to help make their retirement easier. In both scenarios, they have no monthly mortgage payment. However, Tom and Mary are still responsible for paying their annual property taxes, homeowner’s insurance, homeowners association fees, and routine home maintenance. Because there are no monthly mortgage payments made with a HECM loan, it is important that homeowners budget for their annual property charges when preparing their financial budget.

Other Uses for the HECM Product

While the reverse mortgage can now be used to purchase a home, traditionally the product has been used to pay off an existing “forward” mortgage. The elimination of a monthly mortgage payment can make a tremendous difference in the life of older adults who are on fixed incomes. Older homeowners are also using reverse mortgages to do home improvements, travel, pay off credit card debt, and pay for skyrocketing healthcare costs. A new and creative use for reverse mortgages involves funding for an assisted living facility.

Here is a potential scenario: Jim and Judy own their home and have no mortgage. Jim needs full-time care and they decide that an assisted living facility is the best solution. Judy still wants to stay in the home. To pay for the ongoing cost of the assisted living facility, Jim and Judy decide to do a reverse mortgage and take periodic distributions to fund the cost of the facility care. Jim is happy that he is getting the care that he needs and isn’t going to be a burden to Judy. Judy is happy that she can remain in her home knowing that Jim is getting the care and attention that he needs.

How a HECM Works

We all learned in kindergarten that there’s nothing in life for free, right? So, how can you have a mortgage with no mortgage payment? The HECM product is a negatively amortized loan, which means the mortgage balance goes up each month instead of going down like it does in a traditional forward mortgage. The reason the mortgage balance of a HECM increase is that an interest charge is added to the mortgage balance every month. The original loan balance, plus any accumulated interest, is paid back when the homeowner no longer occupies the home as his or her primary residence. If there is any equity remaining in the property at the time the mortgage balance is paid off, that equity belongs to the homeowner (if still living), the estate, or the heirs. If there happens to be a negative equity position, neither the homeowner, the estate, nor the heirs are responsible for any deficiency since the HECM is a government-insured loan. Any deficiency would be paid by the Federal Housing Administration’s (FHA) mortgage insurance fund. With the HECM loan, homeowners never owe more than the value of the home, regardless of the mortgage balance.

For example, when Tom and Mary sell their Florida home, if the property is worth $600,000 and their mortgage balance is $400,000, the mortgage balance would be paid off with proceeds from the sale and Tom and Mary would keep the $200,000 of equity. However, if Tom and Mary’s home declined in value and was only worth $300,000 but they owed $400,000, the shortfall of $100,000 would be paid by FHA’s mortgage insurance fund. The bank will NOT ask Tom or Mary, their estate, or their heirs to pay any shortfall.

Original Reverse Mortgages

Probably one of the most misunderstood products in the mortgage industry, revere mortgages have been around for over sixty years. In the early days, the re- verse mortgage product was a private loan offered by only a select number of banks. Unfortunately, these banks didn’t have sufficient safeguards in place to protect homeowners and, as a result, bad things happened to good people. Reverse mortgages developed a notorious reputation over the years and became a much-maligned mortgage product. The bad reputation continued for years until finally, the government stepped in. In the 1980s, HUD and FHA brought the reverse mortgage product under their oversight and created the modern-day reverse mortgage now known as a Home Equity Conversion Mortgage or HECM. Even today, misunderstandings remain about the HECM product that stem back to the original private reverse mortgages. Perhaps the biggest misconceptions are the falsehoods that “the bank owns the home” and “the bank will keep any remaining equity in the property when the home is sold.” Both statements are 100 percent false! The title to the property always remains in the homeowner’s name so the bank never “owns” the home. Furthermore, if there is any remaining equity in the home at the time the mortgage is repaid, that equity belongs to the homeowner if he or she is still living, the heirs, or the estate.

Safeguards

HUD and FHA have insured the protection of older adults through a wide range of safeguards. The most significant of the safeguards is the non-recourse feature of the HECM product, which means that a homeowner can never owe more than the value of their home regardless of the mortgage balance. Another important safeguard that was instituted by HUD is that all homeowners applying for a reverse mortgage must attend counseling from a HUD-approved counseling agency. Counseling is intended to ensure homeowners are aware of their obligations while they have a reverse mortgage — such as paying property taxes and homeowner’s insurance. Counselors also review triggers for the loan repayment — such as permanently moving out of the home or failing to pay property taxes or homeowner’s insurance.

Mortgage Options

The HECM mortgage is available as a fixed or adjustable-rate loan; the product that is best for a borrower widely depends on the transaction that is being financed. The adjustable-rate product is commonly used for a cash-out refinance where the borrower has either no mortgage on the home or only a small balance that is to be paid off. The adjustable-rate reverse mortgage offers the borrower several distribution options, including cash at closing, a monthly payment for life, or a credit line that can be accessed in the future if and when funds are needed. The fixed-rate product is widely used for purchase transactions or refinance transactions where there is a large mortgage being paid off.

Some borrowers purchasing a home with a HECM may choose the adjustable-rate HECM mortgage to take advantage of the credit line feature that the HECM offers. The adjustable-rate HECM can be paid down to free up equity and establish a credit line that is not available on the fixed-rate product. The HECM credit line is unique in that the credit limit increases over time as a function of the borrower getting older and can never be canceled, regardless of the mortgage balance and/or value of the property. Having the credit line feature is attractive to many borrowers because it can act as an emergency fund if needed in the future.

For older adults considering a HECM mortgage, there are some basic requirements that must be kept in mind:

  • The minimum age for the primary borrower is sixty-two (a co-borrower can be younger).
  • The home must be the borrower’s primary residence.
  • Borrowers must prove their ability to pay property charges (property taxes, homeowner’s insurance,and any association fees).
  • The borrower cannot be delinquent on any federal debt at the time of application.
  • Eligible property types include:» Single-family homes
    » Condominiums that are approved by HUD and FHA
    » Manufactured homes built after June 15, 1976 » Two- to four-unit properties, as long as one of the units is occupied by the borrowerThe HECM mortgage is considered an “open-ended” mortgage — the loan has a defined beginning (at closing) but doesn’t have a defined ending like there is on a traditional 30-year fixed-rate “forward” mortgage. The HECM mortgage becomes due and payable when the last surviving borrower no longer occupies the home as his or her primary residence. The borrowers can live in the home as long as they wish, regardless of the mortgage balance or the value of the home. Borrowers or their heirs have up to one year to pay off the HECM loan once the loan becomes due and payable. If a borrower temporarily moves out of the home, they have up to one year to move back into the property without triggering the repayment of the loan. This feature of the reverse mortgage product is particularly beneficial to a homeowner who may need to be in a rehabilitation facility for an extended period of time.Is a reverse mortgage right for everyone? Certainly not! Certain factors are key indicators that a reverse mortgage may not be the best solution for a client. One very important factor to consider is how long the homeowner wants to stay in the home. For homeowners that have a short time horizon, a reverse mortgage may not be the best solution since the cost/ benefit ratio wouldn’t be in the borrower’s best interest. Those homeowners with long time horizons are best suited to consider a reverse mortgage since the cost of doing the loan is amortized over a much longer period of time. Another situation where a reverse mortgage may not be the best choice is for older adults who believe that the equity in their home is part of the legacy that they want to pass on to their children or grandchildren. For those older adults wanting to leave their homes to their heirs, a reverse mortgage is probably not a wise decision due to the diminishing equity that occurs over time. However, for those who see the equity in their home as another component of their overall retirement plan, a reverse mortgage can be an excellent way to help improve the quality of their lives and help to make retirement easier. For Tom and Mary, the HECM for purchase was the ideal solution that allowed them to purchase their retirement home.

J. D. Dinnocenzo, MBA, CSA, CMP, NMLS #118902 is vice president of reverse mortgage (HECM) lending for Family First Funding, LLC. In addition to originating traditional and reverse mortgages, Dinnocenzo teaches continuing education courses for the Florida Bar and the Florida State Guardianship Association (FSGA) and is a member of the board of directors of the Palm Beach chapter of FSGA. Contact information: 561.617.0036

■ REFERENCES

Herron, J. (2019). Should you get a reverse mortgage? Retrieved

from https://www.usatoday.com/story/money/2019/06/12/ reverse-mortgages-how-do-they-work-and-who-should-consider- one/2881617002/

NewRetirement Editorial Team. (2019). Use a reverse mortgage for purchase of a new home. Retrieved from https://www. newretirement.com/retirement/reverse-mortgage-for- purchase/

Pogol, G. (2019) Understanding reverse mortgage proceeds & how to use them. Retrieved from https://www.moneygeek.com/ mortgage/reverse/payoff/

Sheedy, R. (2015). Buy a home with a reverse mortgage. Retrieved from https://www.kiplinger.com/article/retirement/t037- c000-s004-buy-a-home-with-a-reverse-mortgage.html

Spann, S. (2020). Taking out a reverse mortgage for purchase during retirement. Retrieved from https://www.thebalance. com/purchasing-a-home-with-a-reverse-mortgage-3960734