Last year I was meeting with a baby boomer client couple in the suburbs of Chicago. They were in their early 60s, and we were discussing “What’s Next?” for them as they transition from vocation to avocation (aka semi-retirement yet engaged in life). They mentioned they might like to relocate to the Carolinas, where the cost of living is lower, the climate’s better, and to be closer to family. I advised them to establish a standby expanding line of credit which is a Home Equity Conversion Mortgage (HECM). This could give them tax free cash on their home equity in the event they found a property in the Carolinas sooner than later and needed to act fast to seize the opportunity.
I told them a HECM is a form of a reverse mortgage, and based on the knee-jerk reaction I received, I would have been better off telling them I have a rare form of highly contagious leprosery! Like most people, my clients had a family member or knew someone who had a terrible experience with a reverse mortgage.
Their backstory: Right before the great recession, my clients’ parents took out a reverse mortgage. When it came time for them to exit their residence, the balance of the reverse mortgage was significantly higher than the market value of the home. They were harassed by the lender and suffered emotional stress. No wonder my clients gave me that knee-jerk reaction!
Reverse mortgages have a bad reputation based on stories like the one above. But a lot has happened over the past few years to address the failings and misunderstandings with HECMs. They still aren’t a good decision for everyone, but for some, they can be a great tool to add to your retirement toolbox.
A BRIEF AND ROCKY HISTORY
The concept of a reverse mortgage started in 1961 when a company in Portland, Maine, issued one to the widow of a local high school football coach.1 But it wasn’t until 1988 that the Home Equity Conversion Mortgage Insurance Act was signed in to law by then President Ronald Reagan. It had taken a lot of research and quite a bit of time to get the act passed, but ultimately Congress wanted to see reverse mortgages used to help cash-strapped seniors. They meant well!
Unfortunately, many issues with the program sprang up over the years:
- No financial requirements to qualify – this meant people who didn’t have the money to cover things like insurance premiums, property taxes, and maintenance, were being approved for these loans.
- High costs – Initiating a HECM could cost as much as 6% of the home value.
- High borrowing limits – Borrowers could take out 100% of their line of credit in one lump sum, which some spent irresponsibly or used to fund shady investment schemes.
- No spousal protection – If a non-borrowing spouse was left off the title (due to not being 62 or older), and their spouse died, they had to repay the loan in full or leave the house.
- Predatory lending – Some lenders advised their clients to apply for a HECM and take out the lump sum to invest in other areas that may not have been to their client’s advantage.
OUT WITH THE OLD, IN WITH THE NEW
Many people still think that reverse mortgages are right up there with Ponzi schemes and Pay Day loans. Granted, predatory lenders are out there, but the HECM underwent a serious overhaul starting in 2013:
- A financial assessment is now required to ensure the borrower can make payments.
- Many lenders have introduced a low-fee reverse mortgage product where in some cases, the borrower can receive closing credits so there are no out of pocket costs.
- The Department of Housing and Urban Development requires a counseling session to discourage borrowers from taking too much money too soon as well as imposed an increase in insurance premiums on those who borrow over 60% in a calendar year.
- Non-borrowing spouses can now stay in the home after the death of their spouse.
- Lenders don’t place as much pressure on the borrower to draw on their line of credit.
- The borrower must sign a form if they are going to purchase a financial product, like an equity index annuity, with their home’s equity. (BAD IDEA)
WHEN DOES A HECM MAKE SENSE?
As a fee-only wealth advisor, I want to have every financial tool available to best serve my clients. I advise eligible clients to establish a standby expanding line of credit on their primary residences for several reasons:
- Better plan than relying on Social Security benefits
- Can help fund potential long-term medical needs
- Financing long-term care insurance policies
- Bridge financing to enter a Continuing Care Retirement Community
- Integrating with their retirement spending plan to increase portfolio longevity
- Ensure guaranteed liquidity in the event their home’s value becomes less than the expanding line of credit
Again, a HECM is not for everyone, but if you are eligible, it can be a great way to help fund your financial future!
Rob O’Dell, CFP®, serves clients in our Naples, FL office. With more than 20 years of personal financial planning experience, Rob knows that successful financial planning involves a distinct process, not a one-time event.
Rob has been featured in the Wall Street Journal, Financial Planning Magazine, The Daily Herald and Money Magazine. He was a contributing author on the Third Edition of the Florida Domicile Handbook. Learn more about Rob O’Dell.
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1 “Spotlight – A Historical Timeline of the HECM Program,” Jessica Linn Guerin, The Reverse Review, October 2012, accessed March 21, 2017, http://www.reversereview.com/magazine/spotlight-a-historical-timeline-of-the-hecm-program.html.