Equity For The Kids
Since the end of World War II, the members of the Greatest Generation have been consumed with the hope and desire that their children would have a better life than they had. Much of that is a result of living through the Great Depression and the war years. If you listen to your parents and grandparents who survived those times, you’ll hear them talk about “getting by” with less, and not having any extra money or extra anything else for that matter. Sacrifice was a part of their lives, and even when times became better, they lived in a frugal manner in order that their children would have more.
So, it is understandable when considering a Reverse Mortgage (which we know will increase in size over the years) our parents hesitate. They look at one side of the equation and see that if the mortgage balance increases over time, then the equity must decrease, thus leaving less inheritance for the children. If there were no such thing as appreciation, they would be correct. Fortunately, appreciation is alive and well, albeit hibernating in the early part of 2011, but alive nonetheless.
A quick look at some recent history is in order here. I am using figures for the New York Real Estate market derived from the House Price Index (HPI) which is “designed to capture changes in the value of single-family homes in the U.S.” and is published by the Federal Housing Finance Agency (FHFA). In the last 20 years, New York homes have appreciated by a total of 111% including 4 years where values went down. This gives us an average of 5.55% per year. If we look at only the past 10 years, area homes have appreciated by a total of 68%, for an average of 6.80% per year.
Now, without going into so much detail that your head will start to hurt, let’s look at the basics. John and Mary Smith take a Reverse Mortgage on their $400,000 home at the age of 67 to pay off their existing mortgage. Their initial loan balance is $259,200 and their equity initially is $140,800. After 10 years, the new loan balance is $486,358; and, using an appreciation rate of only 5% per year, at the end of 10 years, the value of their home has increased to $651,557. Thus, their equity has actually increased to $165,199. Even going out to 20 years, their equity is $148,722 after factoring the interest accrual - still a greater amount of equity than the day they started. All this, and we haven’t even touched on the savings from paying off their forward mortgage.
The bottom line is that John and Mary lived a much better life during the years after they closed on the Reverse Mortgage, and still left their children with a great inheritance.
You, too, have a lot of living to do; don’t let the Golden Years pass you by.
Equity Over There, or Equity Right Here
The subject of equity is a part of virtually every conversation about Reverse Mortgages – at least the ones of which I have been a part. Most people have an idea of what equity actually is; in that it is something of value expressed as a dollar figure. As it relates to a discussion of a Reverse Mortgage, most potential borrowers think of the equity in their home as the difference between the home’s market value and the balance due on any mortgages and liens. In other words, the dollar amount that could be converted into cash if the home were sold. In this way of thinking, they are one hundred percent correct.
We often hear the comment that as time passes, the Reverse Mortgage will “eat into the equity of my home.” This is less true than it may seem on the surface. While the Reverse Mortgage will increase in size due to the accrual of interest and mortgage insurance, thereby displacing some of the equity as it exists at that moment, there are other forces acting on the valuation of the homeowners’ equity at the same time. In the realm of real estate finances, a snapshot in time does not tell the complete story. The valuation of real estate is on a time continuum; that is, it varies [mostly] up and [occasionally] down due to market conditions. Thus, we need to step back a bit and look at the whole forest rather than one tree. While it may be true that on the day your Reverse Mortgage monthly statement arrives in the mail, your equity has diminished by one month’s worth of interest; your home is most likely travelling on its path to increased value – and as it goes this route, your equity increases.
Finally, as we look at the word “equity” in the dictionary, there are other words with similar meanings. It now becomes easy to see that Equity = Capital = Wealth, and we can then visualize another concept – something I will call Pocket Equity. Before you close on your Reverse Mortgage, many of you will still be paying monthly payments on your mortgage(s), Home Equity Loans and/or credit cards. So, it follows that the equity that was in your pocket (or bank accounts) has diminished and is now in the possession of your creditors. While you are concerned about the equity in your home, you are reducing your Pocket Equity and probably not living the life style you deserve. After closing on the Reverse Mortgage, you can still watch your home’s equity move with the increased value of the real estate, and watch and feel the increased equity in your pocket without having to make those monthly payments.
Remember, you’ve got a lot of living to do!
Reversing A Foreclosure
We hear – almost on a daily basis - about the rise in foreclosures since the financial meltdown. Of course, Seniors are not immune to the spector of foreclosure, and more seniors are falling behind on their mortgages than at any time in the past. Some may have refinanced earlier this decade when rates were low, real estate appreciation was high, and it seemed like an excellent way to pay off credit card debt. Others are being squeezed between fixed incomes and rising costs of living. Still others, not ready for retirement, may have joined – unwillingly – the ranks of the unemployed, as have so many citizens.
There is possible help for a Senior in this predicament, provided there is still a fair amount of equity remaining in their home. One of the beautiful aspects of a Reverse Mortgage lies in the fact that the borrowers’ credit rating does not enter into the equation of getting approved for the loan. Thus, being in dire financial straits does not eliminate the Senior homeowner from resorting to refinancing via the Reverse Mortgage route.
It is important that the Senior homeowner not hide from the issue, because the costs of the mortgage in arrears will grow each month eating away at the precious equity needed to make the figures work on the Reverse Mortgage. There have been rare occasions wherein the existing mortgagee has agreed to a reduced payoff amount on behalf of the Senior homeowner, but to count on that would be akin to playing Russian Roulette.
As soon as the mortgage payments become difficult or impossible to pay, the Senior homeowner needs to investigate whether a Reverse Mortgage will work in their circumstance. Merely telling your existing mortgagee that you are in the process of “getting a Reverse Mortgage” will not stop the expenses from piling up. Much like when you hear that little noise coming from under your car’s hood, the longer you wait to have it checked out, the more it will cost you in the end.
Over the years, we have helped many of our fellow Seniors back from the brink of losing their home, so we know of what we speak. Do not be embarrassed, we understand and can help.
There Are Always Tradeoffs
Bank Rate looks at Reverse Mortgages and finds there are plusses and minuses. On the plus side, a Reverse Mortgage enables Seniors to generate cash flow, pay expenses, and achieve financial and estate planning objectives….no small set of good features. Generating a flow of money to pay bills and living expenses is a boon to Seniors who may find themselves strapped by their fixed incomes while sitting on – or rather, in – a small mountain of money in the form of wood, sheet rock, nails and flooring. Local supermarkets are still not accepting pieces of carpet in payment for food.
On the minus side, they find that Reverse Mortgages are not for everyone, nor are they some form of free money. Nor should Seniors borrow more than they need. Good advice for everyone I daresay.
“For the majority of people, it makes more sense to take out a minimum amount up front, and then have access to a line of credit. They will owe less in interest over time,” according to Susanna Montezemolo of the Center for Responsible Lending.
Exactly what we’ve been telling our clients for years.
Mystified by Myths
In almost any field there are myths that seem to take on a life of their own until we’ve heard them so many times that they must be true. Certainly the Reverse Mortgage field has not escaped the creation of myths – I hear at least one of these each day. So, today, we’ll endeavor to debunk some of the most often repeated Reverse Mortgage myths.
1. The lender will take my home. No, lenders are in the business of lending – not taking or owning homes. The title to your home remains in your name until or unless you decide to sell the property.
2. I’ll never be approved because my credit is so bad. No, your credit does not enter into the decision of your lender to approve your Reverse Mortgage. Since you will not be making monthly payments on your loan, a good credit report is simply not necessary.
3. I still have a mortgage on my home, so I can’t get a Reverse Mortgage. No, you can still qualify for a Reverse Mortgage if you presently have a mortgage on your home; however, the funds from the Reverse Mortgage will have to satisfy your existing mortgage at the closing.
4. A Reverse Mortgage will affect my Social Security benefits. No, funds that you receive from a Reverse Mortgage are not considered income; thus, are not subject to Social Security regulations. If you are receiving Medicaid, you will need to structure your reverse Mortgage in such a way so as to conform the Medicaid guidelines.
5. I’ll owe taxes on the money I receive from the Reverse Mortgage. No, remember that the money received from a Reverse Mortgage is not considered income; thus, no income taxes are owed to the IRS or state tax agencies.
You Can Take It With You
Though it’s still not as commonly used as the HECM Reverse Mortgage for refinance, the HECM Reverse Mortgage can be used to purchase a home. All the basic rules for Reverse Mortgages still apply: all borrowers must be 62 years or older; the home must be your primary residence; and you must attend a counseling session. Eligible properties include single family homes, 2-4 family homes, HUD approved condos and manufactured homes that meet FHA guidelines. In addition, the funds you will use for a downpayment and the closing expenses must be verified and seasoned. Verified means you must show that the funds already exist in some form in your possession; and seasoned means they must have existed in your possession for at least 60 days. (Gift funds are not permitted in a HECM for purchase.) If the funds are coming from the sale of your present home, the lender will need to see your contract of sale, and the final closing statement (known as a HUD-1 form).
In the past, many Seniors who sold their homes with the intention of downsizing or heading south, had to take all – or most – of the proceeds from the sale to purchase their next home. Now, eligible Seniors only need some of that cash for a downpayment and closing expenses, and can keep the rest for retirement or investment.
Finally, the calculations are somewhat involved to determine how much money you’ll qualify for on your purchase because along with your age, the lender must use both the apprasied value of the home along with the actual purchase price. If this sort of transaction is on your horizon, be sure to contact us and we’ll walk you through the maze.
Saving With the Saver
As we know, the Reverse Mortgage is a loan whereby the borrower can extract equity from his or her home to enhance their financial situation. One of the drawbacks has been the up front cost to close a Reverse Mortgage; however, back in October 2010, the government (HUD) released a new version of the HECM, known as the Saver. The Saver reduced costs as much as 40% by eliminating the up front mortgage insurance premium charged by HUD to insure the HECM loan. This alone reduced closing expenses by roughly $8,000 to $12,000. (There is still a monthly mortgage insurance fee which accrues to the balance of the loan.)
At the same time, many lenders stopped charging a servicing fee on their Reverse Mortgage products, which further reduced expenses by $3,000 to $5,000. The trade off on these cost improvements is that the HECM Saver Reverse Mortgage yields a lower principal amount to the borrower. It seems though that the lower loan amounts have been welcomed by many borrowers who simply don’t need the full amount available on the older HECM Standard. By the way, the HECM Standard is still alive and doing well for those who may need or want the higher loan amounts.
These improvements make the HECM Saver a viable alternative to a Home Equity Loan, especially when you consider that your credit and income are not an issue, and no monthly payments are needed on the Saver or any other Reverse Mortgage.
