Given the downturn in home prices, some seniors who took out reverse mortgages – especially in places like Florida, Arizona and California – are now upside down, or owe more than their homes are worth.
But in the topsy-turvy world of reverse mortgages, being upside down has almost no downside.
Dale Milfay of San Francisco says her 86-year-old mother, Florence, took out a reverse mortgage on her home in Cape Coral, Fla., about four years ago.
At that time the home was appraised for $260,000. Florence qualified for a $160,000 reverse mortgage guaranteed by the Federal Housing Administration.
This type of loan, known as a home equity conversion mortgage, lets seniors 62 and older borrow against the equity in their home without making monthly loan payments. Interest costs and an annual mortgage insurance premium are added to the principal.
The loan balance doesn’t have to be repaid until the borrower dies, sells the house, or moves out for more than 12 months. At that point, if proceeds from the sale of the home fall short of the loan balance, the FHA insurance fund – not the borrower or heirs – pays the lender the difference.
Borrowers can take their reverse loan proceeds in a lump sum, fixed monthly payments, a line of credit or some combination thereof.
Many borrowers take the lump sum because they are paying off a standard mortgage.
Milfay says that because her mom’s home had been paid off, she opted to take monthly payments of $500 for as long as she lives in the home and put the rest into a home equity line of credit, which she taps occasionally for home repairs and vacations.
Each monthly payment, and anything taken from the credit line, is added to the loan balance. Interest is charged only on the unpaid balance, not the untapped credit line. The unused credit line grows at a certain interest rate, so the longer it’s left untouched, the bigger it gets.
Today, Florence’s loan balance is about $75,000, and she has about $105,000 remaining in her line of credit.
But the value of her home has fallen to roughly $80,000.
Milfay asks, “Does she have the right now to take the remainder of her equity as a lump sum while remaining in the house?” Even though her loan balance will soon exceed the home’s value, “it seems to me that since she pays for FHA insurance, she has the right to the rest of the money. Am I right or wrong?”
Milfay is right.
“She can absolutely take out that $105,000,” says Susanna Montezemolo, a vice president with the Center for Responsible Lending.
That would bring her loan balance to almost $200,000. “If the house sells for $80,000, she does not owe the difference. That’s what the insurance pool is for. One of the great features of these reverse mortgages is that the borrower never owes more than the house is sold for,” Montezemolo says. “Borrowers never have to worry whether they are underwater or not.”
Whether she should is a tougher question.
If she knew she might die soon or move into a nursing home, she could take out $105,000, put it in a bank account or money market fund and use it to pay her expenses and leave the rest to her heirs.
The interest rate she earns on her savings will be far less than the interest rate on the bigger loan balance, but if she dies soon or moves out and her home is sold within 12 months to pay off the loan, it wouldn’t matter how much interest was added. Barring an explosive recovery in housing prices, she would still owe more than the home is worth and the government would pay the difference.
On the other hand, if Florence expected to stay in the home for many more years, it might make sense to let the credit line continue to grow. That way, if she needed more money later, she would have it.
“I usually encourage people to wait as long as possible to take it out because the longer you wait, the more you can take out,” Montezemolo says.
No matter what happens to the home’s value, she will always be able to take out whatever remains on her equity line. “The lender must honor the mortgage contract as originally written,” says FHA spokesman Lemar Wooley.
David Certner, AARP’s legislative policy director, says that borrowing money at a higher rate and investing it at a lower rate is “a guaranteed losing strategy.” The only advantage of taking the money out now is that “if she should have a heart attack and die tomorrow, her heirs could not take out any credit line that she had not exhausted, but they could inherit a money market account that she had stashed away.”
The reverse loan is non-recourse, which means neither the lender nor the government can come after the borrower’s other assets, nor the borrower’s heirs’ assets, for any unpaid balance.
Because every situation is different, Florence should check with a financial adviser before making any decisions.
Not surprisingly, “The decline in house prices has adversely affected the projected credit performance” of FHA-insured reverse mortgages, the Obama administration noted in its proposed fiscal 2011 budget. To shore up the program, the FHA recently announced changes designed to reduce risk and increase annual mortgage insurance premiums. To read about these changes, see my Sept. 23 column at sfgate.com/ZKJP.
Higher limits extended: In other mortgage news, Congress passed a continuing resolution last week that includes a provision to extend through September 2011 the conforming loan limit of $729,750 for high-cost areas, including many in California. These are the maximum loan limits for mortgages on single-family homes insured by Fannie Mae, Freddie Mac and the FHA. The higher limits were set to expire at year end. The limits do not apply to reverse mortgages, which have their own set of limits.