Debunking Reverse Mortgage Myths

Sign away and kiss your house goodbye!  That’s what people think, but that’s just one of the myths about the evil reverse mortgage I’ll address today.

 

Is a reverse mortgage right for everyone?  No, but neither is a 15-Year Fixed Rate mortgage.  But that doesn’t make the 15-Year Fixed some type of scam.  I’ve had many questions asked of me recently about reverse mortgages, and I was shocked just how misunderstood this mortgage product is.

 

To understand what a reverse mortgage is, let’s first talk about what a forward mortgage is.  Huh?  A forward mortgage is what we all consider the traditional mortgage when talking mortgages.  A forward mortgage starts with a set balance and has fixed payments of principal and interest for a specific period.  That type of payment structure is called amortization.  At the end of the loan term the mortgage balance is zero.  Mortgage loans, auto loans, student loans, and other personal loans are set up this way.

 

A reverse mortgage works in reverse, hence its name.  You start with a set balance and over time that balance will increase.  During the term of the loan the borrower has several payment options.  Those options are what make a reverse mortgage a very powerful tool for an aging population living on incomes insufficient to maintain their current lifestyle.  Once your reverse mortgage is in place, you have the option each month to make one of the following payment choices:

 

1. You can make a full principal & interest payment – like a forward mortgage.
2. You can make a payment to just cover the interest due – like an interest-only mortgage or HELOC.
3. You can defer from making any payment.

 

I know most of you had no idea about the first 2 options, but it is that last option that generates the most confusion.  If I don’t make any payments, isn’t that how the lender ends up stealing my house?  After all, at some point my mortgage balance will be so large, the lender will want me to sell to repay them, right?  No!

 

With a reverse mortgage, you can live in your house indefinitely as long as you continue to live there as your primary residence, keep your property taxes and homeowner's insurance current, and maintain the property.  The loan becomes due and payable only when you no longer live in the home, sell it, or die.

 

Here’s an example that represents many homes here in Hawaii.  The home is valued at $1,000,000 and you get a reverse mortgage for $400,000.  For our example, we’ll use a loan interest rate of 7% and the borrower won’t make any payments – ever.  For the home, we’ll use a 4% annual increase in value.

 

 

Here’s a shock!  From this chart above, you can see that the balance of the loan never exceeds the home’s value.  Here’s the important part for your kids.  When you pass away your heirs are entitled to the house and the equity.  And just like every other situation when a parent dies and there’s a mortgage on their home, the kids can either keep the home and refinance the balance into a forward mortgage in their name or sell the home and keep the equity.

 

This next section is the most important aspect of today’s topic.

 

If you think I’m being too rosy on the appreciation of your home, and you believe at some point the mortgage balance will catch up and maybe even exceed the value of the home, your kids have nothing to worry about.

 

If you die with a reverse mortgage balance that exceeds the value of your home, here's what happens:

 

1. Non-Recourse Feature

Most reverse mortgages, particularly Home Equity Conversion Mortgages (HECMs) insured by the FHA, are non-recourse loans. This means:

You (or your heirs) will never owe more than the home's fair market value at the time of repayment.

Even if the loan balance has grown to $1.2 million and the home is worth only $900,000, repayment is limited to $900,000.  The remaining $300,000 loss is covered by FHA insurance, not your estate or heirs.

2. Heirs' Options

Your heirs typically have these choices:

• Sell the home and repay the reverse mortgage (keeping any surplus if the home is worth more than the balance).
• Buy the home by paying 95% of the current appraised value (or the loan balance, whichever is less).
• Walk away – let the lender take the home through foreclosure or deed-in-lieu of foreclosure.

3. Estate Implications

• The home is no longer part of the estate’s assets unless your heirs repay the loan.
• Any other assets in your estate are not at risk for covering the shortfall if the reverse mortgage balance exceeds the home’s value.

 

 

One of the ways lenders prevent a reverse mortgage from overtaking the value of the home, is by limiting the initial reverse mortgage balance based on a formula of your age and the equity you currently have in your home.  I believe the same people that came up with these formulas are the same people that set the actuarial tables for life insurance!

From our example above of a $400,000 reverse mortgage on a home valued at $1,000,000, that’s a Loan-to-Value (LTV) of 40%.  The borrower would need to be age 70 to obtain that loan amount.  See where you or your parents fall on the chart below, to determine if there’s sufficient equity to obtain a reverse mortgage.

 

 

 

I see too many people heading into their retirement years facing the heartbreak of being forced out of their home because their retirement income just won’t be enough to cover the expense of living in their home.  A reverse mortgage, while not for everyone, gives those that wish to remain in their home the ability to do so.

 

If you still have questions, I am happy to speak with you confidentially about your specific scenario.

 

 

 

 

 

 

And now the week’s economic news…….

 

Jobs Report Data

News about tariffs continued to cause volatility in mortgage markets this week, with little net effect.  The latest labor market data was a bit stronger than expected overall due to strong wage gains, and mortgage rates ended the week slightly higher.

 

The key Employment report revealed that the economy added 139,000 jobs in May, above the consensus of 130,000, but downward revisions to the results for prior months more than offset the excess gains.  The unemployment rate remained at 4.2%, as expected.  Average hourly earnings were 3.9% higher than a year ago, up from an annual rate of 3.8% last month and well above the consensus forecast.

 

Two other significant economic reports released this week by the Institute of Supply Management were a bit disappointing.  The ISM national services sector index dropped to 49.9, well below the consensus forecast and the lowest level since June 2024.  The national manufacturing index declined to 48.5, also below expectations.  Readings above 50 indicate an expansion in the sectors and below 50 a contraction.

 

The U.S. trade deficit surged to a record high of around $140 billion in March, as companies and consumers rushed to purchase ahead of potentially higher prices.  With the easing of trade tensions, however, more typical levels returned in April.  The deficit dropped by more than half to just $62 billion, which was below the consensus forecast.  Imports fell by a massive 16% from March, while exports increased a little.

 

On Thursday, the European Central Bank (ECB) reduced benchmark interest rates by 25 basis points to 2.0%, down from a high of 4.0% in the middle of 2023.  This move was widely anticipated, and the reaction was relatively minor.  In its meeting statement, the ECB said that the decision was based on its "updated assessment for the inflation outlook" and that rising trade issues pose a risk to economic growth.

 

 

 

 

Next Week

Investors will continue to look for additional information about tariff policies. For economic reports, the focus will be on inflation data. The Consumer Price Index (CPI), a widely followed monthly inflation indicator that looks at the price changes for a broad range of goods and services, will come out on Wednesday. The Producer Price Index (PPI), another monthly inflation indicator, will be released on Thursday. The next Fed meeting will take place on June 18.

 

 

 

 

Until next week….

 

*** Please note that Freddie Mac publishes their weekly rate report on Wednesday mornings from data received Monday and Tuesday. 

The graph above is intended to shown rate trends, and not “today’s current rate”. ***

 

 

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