HOW TO USE A REVERSE MORTGAGE TO PROTECT YOURSELF FROM HOME VALUE LOSSES.

By: Mark Schow

6/2/2011

while reverse mortgages, at times called a reversible mortgage, are often misunderstood they carry with them a host of benefits that are often unknown.  Many financial experts do not understand reverse mortgage lending due to myths about these loans. Because of these myths, many who consult with seniors often lead them to believe that these mortgages have too many drawbacks and should only be used for extreme financial hardship.  Our articles addressing the myths about reverse mortgage loans debunk these misconceptions; however there are reverse mortgage pros and cons that most consumers and even mortgage industry professionals are not aware of or have not considered. One reverse mortgage benefit is the tax planning options outlined earlier.  Another reducing risk from housing volatility. Yes, it’s actually possible to use a reverse mortgage to protect yourself in part from falling home prices. This article focuses on how to use this particular benefit to your advantage.

So how does a reverse mortgage offer protection from market volatility.  This protection is not guarantee of home values, but rather a way of cashing out a portion of the home value without ever having to make payments back the reverse mortgage lender.  Further, there is no risk of taking a personal loss if the reverse mortgage payoff is greater than the home value down the road.  There are limitations and costs you need to be aware of however.  To start with the HECM reverse mortgage works as protection from home value losses because you pull cash out from your homes equity that you have complete control over, while never having to make a payment on the mortgage as long as you live in the home.  As a result, if home values plummet you have already pulled cash out of your home, and have no obligation to make a payment on that reverse mortgage as long as keep it as your primary residence.  You may still use or invest the money you got from the reverse mortgage, but you can never be forced to move out of the home or make a mortgage payment as long as you live in the home. 

Your heirs are also protected as they may choose to turn the home over to the bank without any personal consequences or financial obligation to the reverse mortgage lender once you pass away, even if the reverse mortgage balance is higher than the value of your home.  Regardless of how much value the home may have lost, your heirs will never have to pay the shortfall if they choose to turn the home over to the reverse mortgage bank or lender.  You still got your cash, and if you have cash left from the reverse mortgage proceeds you may leave it to your heirs- so they can come out ahead as well.

On the flip side, if there is equity in your home and you wish to sell or refinance it you keep the equity, not the lender.  The same holds true for your heirs who may choose to refinance the home and keep it, or sell it cash out the equity provided the home value is greater than the reverse mortgage payoff.  Most  of the time the home still has equity remaining when the borrower passes away- but this is not always the case.  Our current housing market has left many with a higher reverse mortgage balance than the value of their home.  They received some degree of protection from home value losses, but are also dealing with the issue of having no equity in their homes.  Of course many homeowners face that issue both with or without a reverse mortgage.  For more information explaining how the equity growth works see "what will happen to my equity"

So how much protection will you get?  Well it's not a full protection of home value, only a partial one.  A reverse mortgage loan's size is determined by the homes location, age of the borrower, and the value of the home.  Only a certain percentage of the home value is lent.  For example, let’s say you borrow 60% of the home value. The protection you get is that you won't lose more than 40% of the home’s value at the time you take out the reverse mortgage.  Basically the loan to value of your loan dictates how much protection you have.  However, keep in mind that the closing costs on the reverse mortgage is now a loss regardless of if you sell the home or keep it.  The reverse mortgage closing costs are subtracted from the loan proceeds at settlement.

So what conditions apply?  First, if you owe more on the home than its worth and you wish to move you would have some issues to deal with.  If the sale proceeds don't cover the loan balance you will have no obligation to pay the shortfall, however no equity will come your way and you will need to work with the lender to transfer title to them. This is a key reverse mortgage benefit as this differs from a conventional mortgage in that the reverse mortgage lenders only recourse is against the home only, not against the home and the person.  As a result the lender cannot get a default judgment against you to pursue any losses they take.  Next, once you pass away your heirs will have a choice to keep the home or turn it over to the lender. They have six months to decide and act.  If they are set on keeping the home and you owe more than its value they would have to pay the shortfall.  However they are free to turn the home over to the bank and pay nothing.

In a all reality it is rare for a reverse mortgage to outgrow the value of the home.  In most cases the equity in the home grows and the borrower can sell anytime without any worries, and the heirs get the equity you decide to remain in the home until you pass away. However, as recent times have shown, it is possible for home values to decline.  That coupled with an increasing payoff balance on the reverse mortgage can result in a reverse mortgage balance being higher than the home value.  Our current housing conditions are resulting in a much higher percentage of reverse mortgage balances being higher than the home value than previous years.

Finally, why does this protection work?  It seems too good to be true at first glance.  It works because of the structure and backing of reverse mortgages. First, FHA insures most reverse mortgages.  The FHA HECM insurance paid at the closing of the reverse mortgage and its ongoing service fees pays (also collected at closing) for insurance against negative equity losses to the lender.  FHA insurance is a cost that shows under the term MIP on the closing statement.  That fee is subtracted from your loan proceeds. Also, because you may only borrow a percentage of the home value it is rare for this insurance to pay out- but has been more commonplace in the past few years.   The protection is only one of several benefits to reverse mortgages.   There are many reverse mortgage loan programs, and because one reverse mortgage program will yield different results from another, it is important that you know all of your options prior to taking out a reverse mortgage.   Please visit our reverse mortgage guide for more information, or contact us with questions.  You can also use our reverse mortgage calculator for quick answers to how much you qualify for.