Should Reverse Mortgages Be Used as a Last Resort?
Changes to Reverse Mortgages
Home Equity Conversion Mortgages, or HECMs, are administered by the Federal Housing Administration (FHA) and make up the majority of reverse mortgages in the U.S. The loans are insured by the federal government against default by a lender (the borrower pays a fee for this protection). The Housing and Economic Recovery Act of 2008 made significant changes to FHA reverse mortgages and how they are sold. For example, the law allows seniors to use a reverse mortgage to purchase a new home (called a “reverse mortgage for purchase“). It also mandates counseling for all FHA reverse mortgages.
Further changes to reverse mortgages came in 2013, when Congress passed the Reverse Mortgage Stabilization Act of 2013, which authorized FHA to change the HECM program. FHA replaced the Standard and Saver HECM options with a single program that is different in a number of ways. For one, it adjusted the maximum loan amount. Based on a formula tied to the borrower’s age and current interest rates, this new maximum is less than the previous HECM Standard, though slightly higher than the HECM Saver option. New limits on the amount homeowners can borrow at closing and during the first 12 months were also implemented. This new limit is 60 percent of the maximum loan amount, though making repairs or paying off an existing mortgage may constitute “mandatory obligations” that could allow for additional borrowing. And lenders are now required to perform a financial assessment of the borrower before a HECM loan can be approved. Part of the assessment is a detailed credit check. These changes helped push the finance industry to reconsider reverse mortgages from a last resort option to a more viable option in retirement planning.
The Compelling Research that Helped Change FINRA’s Position on Reverse Mortgages
Following the changes to FHA reverse mortgages in 2008, FINRA (Financial Industry Regulatory Authority) issued an investor alert cautioning borrowers against reverse mortgages and suggesting they only be used as a last resort. In 2013, one notable research paper, “Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income” (Barry H. Sacks, J.D., Ph.D. and Stephen R. Sacks, Ph.D.), took the challenge upon themselves to determine if using reverse mortgages as a last resort was an optimal choice. The authors discovered that the prevailing position, that HECMs (Home Equity Conversion Mortgages) should only be established after the portfolio was nearly exhausted, was not correct. What the math and science showed was:
“If you use the reverse mortgage credit line in a coordinated fashion—meaning timing it so that it just fills in the down parts of the volatility cycle of the securities portfolio, the portfolio lasts much longer, and most important for any retiree, the cash flow survives much longer. It survives so much longer that in many cases, it doubles the probability that the cash flow will last as long as the retiree does.” – Dr. Barry Sacks
Dr. Sacks’ took his research to FINRA and was so persuasive in their conversation that in October 2013 it led them to change their “reverse mortgage as a last resort” position and remove the language from their investor alert.
“It’s not for everybody. But it’s not negative anymore, it used to say ‘use a reverse mortgage as a last resort option.’ But after Barry Sacks convinced them that was the worst possible way to use a reverse mortgage, they took that language out.” – Dr. Wade Pfau, Ph.D.
FINRA’S 2014 alert urging homeowners to reconsider their position on reverse mortgages can be found here.
To find out more about reverse mortgages and if they may be a good option for your retirement plan, send us an email at help@retirementpowerhours.com or give us a call at 508-798-5115.
