Home equity creates retirement options

The dream of many downsizing seniors is to sell their home that has become too big, buy a smaller home and pay cash so that they no longer have a mortgage - then use the rest of the proceeds toward their retirement.

But what if paying cash for that new house is not the wisest course?

Many people 62 and older don't realize that they can actually take out a reverse mortgage to purchase a new house, freeing up much more of their equity for use during retirement, said Richard Glover, director of the Reverse Mortgage Division of American Fidelity Mortgage Services Inc. of Lisle.

American Fidelity is a HUD-endorsed direct lender (not a broker) that offers a reverse mortgage called the "First Resort Home Loan," which can be used to buy a home. Instead of locking up much of their capital in their new home, seniors can use these lending options to enhance their cash flow during retirement.

In 2007 when the housing crisis hit, it became difficult for people to downsize because they lost equity. So, they waited for values to recover.

"Now that values have recovered we are looking at a lot of seniors potentially downsizing," Glover said. "If they tie their money up in a new house versus properly using a HECM for purchase, it could put a strain on their retirement years down the road."

As people grow older and retire, they confront the problem of having enough money to live on and enjoy life, and at the same time, being able to stay in their current home or the home of their choice. So much of their accumulated wealth is tied up in their home that many end up "house rich and cash poor," Glover said.

The late congressman Jack Kemp, secretary of Housing and Urban Development under President Reagan, actually anticipated this problem back in the 1980s and had his experts develop the Home Equity Conversion Mortgage (HECM) program, which is popularly known today as a "reverse mortgage."

This program, which is guaranteed by the Federal Housing Administration and backed by HUD, gives people 62 and older access to the equity they have built up in their homes without having to make any monthly payments, Glover said.

HECM borrowers can use the reverse mortgage to purchase a new home or to stay in their current home, he added. The advantage of using a HECM mortgage to downsize after retirement is that you don't have to worry about income or asset problems in order to qualify.

"If a 67-year-old couple bought a house in Naperville 30 years ago, for instance, and it is now worth $400,000 but has become too big for them, so they want to downsize and move, they may think that they can just take $250,000 in cash from the sale and buy a new, smaller place and then have the extra $150,000 for retirement," Glover said.

"But if instead they use a First Resort Home Loan to purchase the new home, they would only have to bring $175,000 to closing, instead of $250,000, and then they will have $225,000 for retirement instead of $150,000. Closing costs have also been lowered in the past year and they will have no monthly payments other than their property taxes, insurance and maintenance," he continued.

"Starting April 27, however, HUD is implementing new, more stringent guidelines to determine whether or not someone can afford their property taxes and homeowners insurance as a regular expense. At American Fidelity we are currently training our team to help our future clients get through the process in the best way possible," he said.

Worried about the disinformation they have heard about reverse mortgages, many senior citizens think that the best way to access their home equity is to get a Home Equity Line of Credit, or HELOC, from their local bank, Glover said.

"But a HELOC can be the most dangerous instrument for a senior borrower. The bank can cancel your line of credit, and/or they can reduce the amount of available credit at any time, at the bank's discretion. Most HELOCs either have a balloon payment due in a lump sum or after 10 years there is a fully-amortized payment required until the balance is paid off over a period of time - 10 to 20 years. These options make this decision less desirable. Ten years from now, it is likely that your household income will not be sufficient to support a larger payment and if you can't make the payment, you could lose your home."

With a reverse mortgage, on the other hand, you have the ability to establish a line of credit without the dangers of a typical HELOC.

"In this case, everything is guaranteed until you turn 150 years old so that you don't outlive the terms. You can get things done in reverse," Glover said. "You can get a lump sum, you can get a payment made for the remainder of the time you live in the house. You can get a 'term' payment for a period of years or you can leave the money on the line of credit. This annuitizes your home's equity because the available unused funds will grow at a rate equal to your interest rate."

In the case of Glover's hypothetical homeowner, one year after they initiate the loan, they will have a $50,000 line of credit they can draw against that will increase to $80,000 after 10 years and $140,000 after 15 years.

"The long-term results are that these particular homeowners would have that initial $225,000 to invest immediately and, if no funds had been drawn, another $140,000 to fall back on 15 years in the future so they would be able to actually use $365,000 of the $400,000 that they got from the sale of their longtime home," Glover said.

"This is all regardless of the value of your home and is backed, guaranteed and insured by HUD through the FHA," he added.

"But if they do need to draw money, that credit line is always there when they need it and cannot be canceled as long as they are within the terms of the agreement, which includes occupying the home as their primary residence," Glover said.

"The worst thing a senior can do is have income because that increases their tax liability and is self-defeating. But if you draw against funds that are yours, it does not count as income and is not taxable," he said.

If the homeowner chooses to receive payments, they can arrange to have them made for only a certain number of years or for the entire time they live in the house. The nice thing, Glover said, is the homeowner can change the terms any time they wish by only paying a $20 re-administration fee instead of paying the fees and taking the time involved in a regular refinancing.

In addition, a misconception is that reverse mortgages are expensive loans. There are different cost structures depending on the percentage of available funds accessed when the loan is set up and the amount of money drawn at closing. But Glover said the costs can be comparable to that of a standard mortgage.

And what many homeowners and their families worry about, but are often too delicate to ask, is: what happens to the equity if the homeowners pass away soon after the mortgage is set up or, conversely, what happens if the homeowners live past 100 and the money runs out?

"If there is equity remaining in the property, the heirs sell it, pay back the money owed by the homeowners, and keep whatever is left over," Glover said. "But if the homeowners are upside-down on the mortgage when they pass away, the estate, nor the heirs, is NOT on the hook. FHA mortgage insurance covers any and all shortages."

American Fidelity Mortgages Services is one of only a handful of HUD-approved, FHA direct-endorsed mortgage bankers based in Illinois, Glover said, which is very important.

Most of the companies offering reverse mortgages are simply brokers who are less nimble and less experienced and do not specialize in setting up these kinds of scenarios, he said. Most also do not understand the intricacies of HUD regulations, so they may make homeowners jump through unnecessary hoops, Glover added.

"We are focused on getting seniors the proper help in obtaining these excellent, but complex, mortgages. If more people realized and understood the features of these mortgages and looked past the misconceptions, a reverse mortgage would be and should be a more common aspect of retirement planning," he said.

For more information about a reverse mortgage, call American Fidelity at (847) 464-8080.