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Reverse Mortgages

News Flash - HR 5640, effective December 12/00

HUD will implement the American Homeownership and Economic Opportunity Act of 2000 in June, 2001 (approx.) that will waive the upfront fee for the mortgage insurance premium for seniors who use the money from a reverse mortgage for long-term care insurance premium. The value of the waiver is 2% of the lending limit, which varies by state. (For example, a lending limit of $132,000 in Colorado on a $200,000 residence results in a waiver of $2,640.)

Excerpt from Phyllis Shelton’s Long-Term Care: Your Financial Planning Guide :

Since the majority of older Americans own their homes and have paid off their mortgages, many people find themselves “cash poor” and “house rich.” Because of these characteristics, a certain amount of activity is occurring in the marketplace to help people tap the value of the home without giving it up as long as they live in it. Converting the equity of the home into cash can be accomplished either through sale plans or loan plans. The sale plans, which involve selling the home then leasing it back as long as the seller is able to live in it, are not popular for tax reasons. It’s possible that the IRS will not view the plan as a bona fide sale if the house is not sold at fair market price, or if the buyer is receiving favorable treatment, or if the buyer does not assume full ownership until the death of the seller. If the IRS does not view the plan as a bona fide sale, the one-time capital gains exclusion is not available to the seller. In other words, people sometimes try to give their kids a bargain, and the IRS doesn’t look favorably at special deals for children or any other buyers.

Home equity conversion loans in the form of reverse mortgages are available, in which no repayment of the loan is generally required until the borrower dies, sells the home, or permanently moves. Started by the federal government in 1988 to help older Americans on fixed incomes, the program allows homeowners over 62 to “cash in” on their home equity. You must be a single-family homeowner, which can include a condominium or townhouse as long as the development meets FHA guidelines. Others who are not on a fixed income also see the benefits of “cashing in” on the equity in their home for additional investments. There are no income qualifications and limited credit qualifications, because unlike an equity loan from a bank, a reverse mortgage requires no monthly payments.

The monies available to the homeowner are tax free and don’t count as income for Social Security eligibility purposes. The balance due grows as monies are disbursed to the homeowner. The funds can be disbursed in several ways. Cash available can be taken in monthly payments over a period of years, a lifetime, or as a line of credit you can draw down as needed over a number of years. You can even receive a combination of regular monthly payments and a line of credit. You still own the home. It can be sold at any time (for example, if you decide to move) and when sold, any balance due on the reverse mortgage is paid and the remaining equity goes to you or in the case of your death, to your estate. Equity remaining would depend on how long you remain in the home and the value of the home at the time of sale.

The reverse mortgage market is poised to grow substantially as the baby boomers move into their retirement years.  As of this writing, there are four products available but that will increase to meet various demands of clients.  Presently the most widely used product is FHA’s Home Equity Conversion Mortgage (HECM). The Federal National Mortgage Association, known as “FannieMae,” offers a product called the Home Keeper. FannieMae doesn’t make direct loans. It buys loans from lenders, packages them and resells them to investors. Financial Freedom (www.financialfreedom.com), headquartered in Irvine, California, offers two private reverse mortgage products.

According to a November 9, 1995, article in USA Today, “The older you are and the more valuable your home, the more you can borrow.” Each program has a “lending limit” and the amount available to the client depends on age, and in some programs, on the number of borrowers (but all have to be over 62). It also depends on the value of the home and the interest rate used to calculate that amount. For example, in the FHA program, a 74-year-old in a $180,000 home could gain access to $98,820, which could be set up as monthly income or as a line of credit. FannieMae offers two options—that same borrower could get $77,760 in the equity share program and $61,576 in the non-equity share. The “equity share” provides more money on the front end, but there is a penalty on the back end. The “non-equity share” provides less money on the front end and no penalty payment on the back end. FannieMae is utilized more frequently by older, single people than by married people.  The Financial Freedom products are geared to higher valued homes, so borrowers who are 74 and 76 who live in a $500,000 home for example, could be approved for $127,326 to $133,548.

If you take the money in monthly payments but live so long that the payments exceed the home’s value, you or your heirs do not have to pay back any amount larger than the worth of your home. After you die, your children (or other heirs) can keep the home if they like—they just have to pay the balance in full. They can pay off the reverse mortgage using their own money or they can sell your house. If they sell your house for more than is owed, they can keep the difference.

The interest rates on reverse mortgages are adjustable.  Interest adds to the balance that will be owed when the property is sold. FHA offers either an annual or monthly adjustable interest rate and FannieMae has only a monthly adjustable.  FHA’s rate is the weekly average of the one-year Treasury Bill plus a margin of 1.2% for the monthly adjustable or 2.1% for the annual. For example, on April 24, 2000, the one-year T-Bill was 6.14%, so the annual rate was 8.24%. (Since 1985, the highest FHA monthly adjustable rate has been 9.26% and the lowest was 4.62%.)  FannieMae’s rate is the weekly average of the one-month CD rate plus a margin of 3.40%. The one-month CD rate on April 24th was 6.07%, so the rate for a FannieMae reverse mortgage was 9.5%. Monthly adjustments to this interest rate will not affect monthly payments (but this may effect credit lines, if you choose to take your money as a line of credit). This will only effect how much money is owed when you die or move out of your home.

A list of lenders and an informational brochure is available by calling FannieMae at 1-800-732-6643.

To make sure families understand the program, FHA requires a free individual information meeting with a HUD-approved housing agency separate from the lender so you can learn about the program objectively and decide if it’s right for you. Paulette Wisch at Financial Freedom (303-843-0480 or 800-843-0480) can give you a free no-obligation package of information with a list of the HUD agencies.

Most of the cash from the various plans has been used for home repairs, to weatherize homes, to make homes accessible for the handicapped, for basic living expenses, and some of the money is being used to fund long-term care services. Rather than pay for the long-term care services directly, much more “mileage” can be obtained from the money by purchasing long-term care insurance if you are insurable. You can purchase a long-term care policy outright by paying a monthly, semi-annual or annual premium, or a lump-sum obtained from a reverse mortgage can be used to purchase an annuity, which can then be set up to pay the LTC premiums for the rest of the insured’s life. Or, the lump sum can be used to purchase a life insurance or annuity long-term care policy as described on pp. 162-174 of LTC: Your Financial Planning Guide that pays LTC expenses with a guaranteed premium.

Your State Agency on Aging also has information on organizations to contact if you are interested in obtaining a reverse mortgage. The June 1997 AARP bulletin contained a warning from Andrew Cuomo, the Department of Housing and Urban Development (HUD) secretary. Mr. Cuomo cautions against salespeople contacting you to do a reverse mortgage and charging hefty fees for information and forms that HUD offers free. He said the legal limit for counseling and referral services is $50, and you should not be charged more than that. If you suspect a scam, you can check out the organization that contacted you by calling HUD directly toll-free at 1-888-466-3487, and HUD will investigate at no charge to you.

In summary, one funding method for long-term care does not fit all.  Since this is America, it’s safe to say that we will continue to see much product innovation and variety throughout this century as our country struggles to find a way to pay for long-term care with private funding as much as possible and prevent unprecedented taxation—the inevitable result if the baby boomers wind up on any kind of public assistance for long-term care.

© 2001 Shelton Marketing Services, Inc.

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