Are Reverse Mortgages Expensive?

There are several myths about reverse mortgages: the lender will take your house, they’re very expensive, the kids won’t get anything, etc.  Ongoing and recent changes by HUD to the FHA-insured reverse mortgage program have enhanced its long-term stability and suitability as a solution to one of America’s biggest demographic challenges – bridging the gap between longer lifespans and insufficient retirement savings.  Here we will consider the claim that reverse mortgages are expensive.

All home loans are more complicated and expensive since the financial crisis; largely because the government added layers of regulation, which borrowers end up paying for in higher costs and added time.  The term “manufacturing quality” is now the most important aspect of mortgage lending.  Lawsuits have been filed against lenders and many see the large fines and settlements as being less about infractions and more about a newfound revenue source for the government.  Clearly the pendulum has swung from too far on one side to too far on the other side.  So, are reverse mortgages really expensive?”

Anytime you hear the statement, “That is expensive,” you have to ask, “Compared to what?”  When talking about a mortgage (forward or reverse); if we’re comparing them to cash, well, yes, they’re expensive.  But since most of us don’t have hundreds of thousands of dollars lying around; mortgages, car loans, insurance, etc., are a necessity.

To put a finer point on it, the next question is, “Are reverse mortgages more expensive than normal (forward) mortgages?”  Even here, we have to draw a distinction between an insured mortgage and one that isn’t.  When a young couplebuys their first home, they often use an FHA-insured mortgage because it allows for a smaller down payment, higher debt ratios, and previous credit challenges.  With house inventory low, and affordability getting away from people, FHA forward mortgages are an important product for people seeking to realize the American dream of home ownership.  The reason banks make low-down-payment loans is because of the FHA mortgage insurance – it protects the lender if the borrower defaults.  If it wasn’t for that insurance, the bank would require a 20% down payment, higher credit scores, and a debt ratio under 43%.

So a better question might be:  is an FHA-insured reverse mortgage more expensive than an FHA forward mortgage?  Before we answer that, let’s talk about insurance.  All insurance costs money.  The question is what does the insurance get you and how much does it cost?

On a forward loan, whether we’re talking FHA or even PMI, the mortgage insurance only protects the lender in case the borrower defaults.  The benefit the borrower gets is second-hand; namely the loan they need would not be available if the lender wasn’t insured by the government or a private mortgage insurance company.

With a reverse mortgage, the FHA insurance not only protects the lender (thereby making the loans available), but in several important aspects the insurance specifically protects the borrower by guaranteeing that:

• Monthly checks (tenure or term) will continue – even if the lender goes out of business
• Future access to any unused proceeds will remain – even if the lender goes out of business
• The reverse mortgage line of credit will not be frozen or cancelled – like happened with traditional HELOCs in the financial crisis.
• The unused reverse mortgage line of credit (the available limit) will increase every month, over the life of the loan, even if the home’s value doesn’t go up.  This feature is unique to reverse mortgages.
• Borrowers, or their heirs, do not have to make up a shortfall if their reverse mortgage loan balance is greater than home is worth at the end.  This is known as a non-recourse loan.  If there is a shortfall, the insurance pays it, not the borrower’s estate.

All five points are characteristics that make reverse mortgages valuable wealth management planning tools.  CFPs, financial advisors, CPAs, trust attorneys; everyone involved in retirement planning is looking to help seniors have more monthly cash flow and a safety net for unexpected expenses.  The FHA-insured reverse mortgage (also known as a HECM) guarantees that those benefits will not disappear, even if their lender does.

But what about the question, “Are reverse mortgages much more expensive?”  Perhaps a good way to provide some clarity is with an example comparing a forward and a reverse mortgage.  The summary below is for a $400,000 FHA-insured forward mortgage, and an FHA-insured reverse mortgage with a principal limit of $400,000, on a home valued at $625,000.  Admittedly, this comparison is a bit artificial; like comparing a hammer and a screw driver – they are different tools, but the table below is enlightening:

The point of this article is not to say that reverse mortgages are much less expensive than forward mortgages, but rather to illustrate that today’s reverse mortgages are not significantly more expensive; they can actually be less.

In a future post, we’ll discuss what the origination fee covers.  With both forward and reverse mortgages, lenders can reduce the out-of-pocket investment borrowers make by charging slightly higher interest rates.  When advised by a competent mortgage planner, these options can be advantageous in the short and/or long run.

Also, today lenders may offer a reduced origination fee when the mandatory obligations and/or the initial draws exceed $100,000.  Rates, fees, and loan programs change continually.  The example illustrated above is not a guarantee of fees, products, or loan availability.  To discuss your specific situation, feel free to contact me: kent@theReverseAdvisor.com or  (800) 208-1252.

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