Rethinking Reverse Mortgages

Reverse mortgages -- a way for seniors to tap into their home equity without having to make monthly payments -- have become a mainstream retirement-planning option in recent years. Despite some drawbacks, for many retirees, a wisely chosen reverse mortgage has helped fund a comfortable, active retirement when savings and pensions alone weren't sufficient.

But recently, the reverse-mortgage picture has gotten very complicated.

Consider: The conventional wisdom around reverse mortgages has long been that retirees should wait as long as possible before taking one. There are two reasons for this:

  • Reverse mortgages usually have an actuarial component, meaning that the lender looks at your likely remaining life expectancy when deciding how much to lend you. The older you are, the better your chances of getting more money. More money is good.
  • Historically, houses have appreciated over time, so that (according to the conventional wisdom) the longer you wait, the more equity you'll have. The more equity you have, the more money you can get.

You see the problem, don't you? (If not, read that second bullet point again. It'll come to you.)

Yes, reverse mortgages are yet another area to take a hit from the declining housing market. Not only are reverse-mortgage lenders such as IndyMac Bancorp (NYSE: IMB  ) and Wachovia (NYSE: WB  ) reeling from the housing crisis (and tightening up their lending standards across the board accordingly), but also for those on the borrowing side of the equation, you probably have less home equity than you did a year or two ago.

To be clear, reverse mortgages aren't the real cause of banks' pain. The most popular type of reverse mortgage -- the home-equity conversion mortgage -- is guaranteed by the Federal Housing Administration (FHA) and widely available through major national players such as Bank of America (NYSE: BAC  ) and Wells Fargo (NYSE: WFC  ) . And although Fannie Mae (NYSE: FNM  ) and a few other lenders offer custom products that aren't backed by the FHA, the problems -- from the banks' perspective -- are elsewhere.

But that declining equity is a big problem for borrowers. According to a new study from reverse-mortgage broker Golden Gateway Financial, a 72-year-old potential borrower who owns a house that was worth $200,000 in January 2007 would be able to borrow about $17,000 less now -- roughly $126,000, versus $109,000 -- than he or she could have a year ago. Because the value of the home has fallen, the owner has already taken a hit of more than 14%.

Now, that's a nationwide average, and depending on where you live, your mileage will surely vary. But no matter where you are, odds are that your home equity has taken a sizeable hit over the past year. Mine certainly has.

That hit means less money for your retirement. And although I don't have a crystal ball, I don't see the housing market recovering to early 2007 levels any time soon. It may even get worse.

What to do?

Thinking it through
When a longstanding rule of thumb goes out the window because of a change in market conditions, the best thing to do is take a deep breath and apply some common sense.

Is this a bad time to take a reverse mortgage? Not if you need the money. Waiting for the market to recover could mean a lot of uncertainty -- you could wait six months or 10 years. But if you need the money immediately, and a reverse mortgage is the best fit for you, that's an excellent reason to take one now -- without losing sleep over the what-ifs.

Is waiting a few years to take a reverse mortgage a bad idea?  I can't predict whether your home equity will be lower in a few years, but I can predict that you'll be a few years older in a few years. And when you're a few years older, those actuaries will be likely to lend you a larger proportion of the home equity you do have. So based on what I do know, I say that if you can wait, wait.

What else should I know? A lot more -- these are complicated products with many traps for the unwary. If you're seriously thinking about a reverse mortgage, read Doug Short's dissections of the pros and cons in the February and December 2006 issues of the Fool's Rule Your Retirement newsletter. (It's a paid service, but a free trial gets you full access for 30 days with no obligation, so click with confidence.)

And while you're in the Rule Your Retirement archives, check out Robert Brokamp's article from last September on alternative ways to tap your home equity. One of them might be a better fit for you.

Fool contributor John Rosevear owns none of the stocks mentioned in this article. Bank of America is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 18, 2008, at 9:48 PM, jeskydive wrote:

    Please note that regardless of equity, Reverse Mortage will only pay you on $200,000 worth MAX! Maybe that's why the author used this figure.

  • Report this Comment On June 19, 2008, at 10:31 AM, TMFMarlowe wrote:

    Yes and no. FHA does limit the amount of equity that can be considered in reverse mortgages they back, and that limit varies by region (from about $200k, as you said, to about $363k in high-value markets). Non-FHA-backed reverse mortgages have limits set by the individual lender, and vary widely. As always, make sure you understand before you sign.

  • Report this Comment On June 19, 2008, at 11:38 AM, kurthjackson wrote:

    No mention of the guaranteed growth function in the FHA HECM. The amount of the available Line of Credit grows at the amount of the interest rate including the .5% Mortgage Insurance premium (using the 1 Year CMT + 1.5% margin + .5% MIP the 20 year avg. is 6.54%).

    That gives you guaranteed growth in equity. When you couple that with the current limits on max loan amounts that could mean one should get a Reverse Mortgage now vs. waiting.

    Assuming the 20 year average a $100,000 LOC that goes unused would be worth $106,540 after a year and $113,507 after year two.

    Run the #'s it could be a benefit to get one now and enjoy the guaranteed growth in equity especially if you are in an area where values are dropping.

  • Report this Comment On June 20, 2008, at 8:02 PM, reversemortgage wrote:

    Another aspect for consideration is the interest rate. An interest rate is used in the life expectancy formula to determine the amount available . Therefore, even if the housing market recovers and home prices go up it does not mean the same amount of money or more will be available. Yes, they will also be older. Although the rate plays a larger role in the amount available then age or home value do. Now is the time because rates have only one way to go

  • Report this Comment On June 21, 2008, at 3:04 PM, RMGuru wrote:

    Ditto on credit line growth feature of the FHA HECM. In effect it's a hedge against declining real estate values when conservatively managed. Then when real estate takes another leap, and you're older, you can refi the reverse and get a bigger LOC. Win, win, win. If Congress passes the pending FHA Modernaization Act (part of the foreclosure relief bill) and if Bush doesn'r veto it, the FHA HECM lending limits will be raised to $550,440 nationwide. If only the real estate market would catch up! Finally, beware of journalists who write stories about reverse mortgages. They are not well-informed about the subtle nuances and often draw erroneous conclusions to support bad advice. Talk to an expert.

  • Report this Comment On June 24, 2008, at 3:08 PM, ou8mynookie wrote:

    For Reverse Mortgages in FLORIDA, call the experts @ 813.854.2666.

  • Report this Comment On June 30, 2008, at 1:24 PM, rmcinturff wrote:

    Not sure if the article should have been published. One of the issues with a national publication is that it generalizes. In the DC Metro area the home values are usually above the FHA lending limit, so this article would scare someone into believing they can't get the cash they need if home values had decreased. Regardless that their home value is $375,000, 400,000 or even $550,000, its still more than the lending limit and even with home values falling they would receive the same amount of equity access on the FHA program. Jeskydive, your point is only valid in counties where the lending limit is $200,160. Other counties have limits as high as $362,790, so someone could get as much as $290,000 in equity access. That will pay a LOT of bills and help them sleep at night.

    The article doesn't allude to the proposed increase in lending limits nor does it touch on the very important credit line growth feature. Also, Wachovia is not writing reverse mortgage business at this time and it implies that it does.

    The reverse mortgage is a great tool for those trying to get out from under a regular forward mortgage and for those that depend on social security income as a monthly cash flow supplement, regardless of home values because it does not have to be paid back as long as the borrower remains in the home. Articles on reverse mortgages should be handled by experts in the business as the general financial planning fraternity doesn't fully grasp how they work.

  • Report this Comment On February 16, 2013, at 2:34 AM, Richard192 wrote:

    I think you have made some truly interesting points. Not too many people would actually think about this the way you just did. I am really impressed that there's so much about this subject that's been uncovered and you did it so well with so much class. Good one you man! Really great stuff here. To learn more simply search reverse mortgage lenders direct

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