Over the years reverse mortgages have shifted from being a choice of last resort to a creative and effective retirement planning tool. But still many who do not fully understand how reverse mortgages function will immediately bring up the perceived high cost of originating the loan.
When all costs and variable options are considered, the opposite is true. Reverse mortgages actually cost considerably less when used as a source of income when compared to a portfolio or continuing to make payments from a portfolio after the age of 62. They also allow for financial freedom during some of the most important and valuable times in life.
Let’s start by looking at the actual costs. People are generally familiar with the costs that come with a traditional forward mortgage. They do vary by state but consist of lender fees, third party fees like appraisals and title costs, origination fees, PMI and other miscellaneous costs.
All of those are similar to a reverse mortgage with the exception of one difference: Mortgage Insurance Premium (MIP). This is a 2% fee based on the home value which goes to the FHA to insure the loan.
So, what does that insurance fee get you? Why is it required?
In the case of a traditional forward mortgage, insurance encourages the lender to lend to a borrower with a lower credit score or a small down payment so they are insured by the mortgage insurance company if there is a default. Reverse MIP is much more powerful than forward PMI. It not only insures the lender, but also the borrower AND the borrower’s heirs. The reverse mortgage is a non-recourse loan that requires no payments until the borrower passes away or moves out of the home permanently. That’s a solid guarantee.
As we’ve seen the past few years here in Colorado, home values continue to rise. And just as we’ve seen before, that’s not guaranteed to continue forever. No one really knows what the home value will be next year or a decade from now. With this MIP, the borrower can live a very long life, and even if the home value plummets, if the balance on the loan is more than the value of the house, the MIP fund pays out the loss to the lender. The borrower, or the borrowers’ heirs, will never be responsible for any negative gap between loan balance and home value or any tax liability.
Additionally, it’s very common that there is equity left over to pass on to the children because the home value has increased faster than the loan balance. In this case, even with the FHA insured loan, the heirs will always receive any equity in the home.
Now how do you calculate these additional costs into a financial portfolio? Let’s look at some ways a reverse mortgage can be used.
The first factor is often also the biggest benefit – eliminating a mortgage payment so that cash flow is freed up to invest or use for other purposes. Currently 44% of seniors reaching the age of 62 are still making a mortgage payment. Most can afford it, but it needs to be asked if this is the best use for the money.
The second factor to consider is for those who are wealthy and have what one would consider “plenty of money” with homes that are already paid off. These people still have a cost of living, and often it is high. The funds to maintain their lifestyles has to come from somewhere, whether passive or active income. A reverse mortgage just acts as another source of income, and it is often the most efficient and cheapest income available to someone past 62. Advisors can keep their senior clients fully invested in longer term portfolios while maintaining a cash reserve in the reverse mortgage line of credit. And that line of credit is guaranteed never to be cancelled or closed as long as the borrower meets their basic responsibilities such as paying homeowners insurance, taxes, and other basic fees such as HOA. It also requires no payments and is guaranteed to increase every year that goes by even if the house value does not.
And the third factor is quality of life. As these individuals plan for the rest of their lives in a way only retirees do, the answer isn’t always calculated in dollars and cents, it’s calculated in time spent vacationing with grandchildren and creating memories with friends and spouses. This particular return on investment should never be overlooked.
Jan Jordan is a Reverse Mortgage Specialist serving the Fort Lupton, Erie, Lafayette, Fort Collins, Loveland, Greeley, Longmont, Boulder and other Front Range areas of Colorado. Click here to contact Jan and learn if reverse mortgage is right for you.