Right. There is a slight risk to the mortgage company. That’s why the LTV starts out so low, and increases gradually with the borrower’s age. The real risk, of course, is declining property values.
Which is another way that the actuaries have you at the disadvantage. My mother works in the nursing home field and they say that the average length of stay in a nursing home is two years, so…
Ok, I deal with these every day, so I figure its about time that I chime in. Basically a reverse mortgage should only be considered by people who are having great financial difficulty.
Lets say little grandma Jane has depleted her savings accounts and isn’t able to live off of her Social Security anymore. She owns a home worth 250,000 which has a home equity line on it, say 30,000 that she’s making interest only payments on. She’s so hard up for money that she feels that the only way to make ends meet is to keep drawing on her home equity line of credit to patch the hole in her budget.
If this continues eventually poor grandma will max out her Home equity line and will no longer be able to make the payments. She’ll be forced to sell the home pay off the home equity line and end up moving into a nursing home on title 19 with nothing. This, of course scares the hell out of poor grandma and she has no idea what she should do.
She is far and away the perfect candidate for a reverse mortgage. After going through counseling to be sure this is right for her we would do a reverse mortgage in her name. The bank would pay off her first mortgage so she no longer had to make any monthly payments and the bank would guarantee her $540.00 a month every month until she either moves out of her own free will or dies.
So grandma loses a big bill, gets extra money every month, and most importantly she will NEVER be forced to have to move out of the home for financial reasons. The bank does NOT own the home outright.
Now for the “catch”, The reverse mortgage is a loan just like any other, so even though she isn’t making payments the balance of the loan is growing every month, not only by the $540.00/month, but also the interest on the loan. In addition, the bank gets a HUGE chunk of money (usually around $7,000) in closing costs just for doing the loan.
So lets say that Grandma only lives 5 more years, when grannie dies the house goes on the market. Lets say that the home that appraised for 250K 5 years ago now sells for 300K. The bank takes the 300K, subtracts the 30K original mortgage, the amount of the monthly payments (~33K), the 7K closing costs, and the amount of the interest paid. So her heirs would get maybe 190K.
Heres the kicker though, lets say that grandma defies the odds and lives to be 115. In that time the bank pays her 300K in monthly payments. Lets also assume the worst housing market in history. When her house sells we find out that its only worth 200K. So when she dies and the house sells the bank doesn’t even make half its money back. Thats ok too because the loan is insured by the FHA, so even if the bank loans out 10 times more than they get for it the government reimburses the bank for the loss.
Thats important enough of a point for me to restate: No matter what the house sells for the bank will not be out any money. Its risk free.
There are other issues that I could touch on, but I think I’ll save them as rebuttal.
The real downside is the very high cost of the reverse mortgage.
The up front fees can be $20, 000 or more on the ones I’ve seen.
This is how the lenders protects themselves.
One has to live quite awhile to make these up front costs worth it.
Ottoerotic, you start out by saying “Basically a reverse mortgage should only be considered by people who are having great financial difficulty.” Why? The “huge” chunk of money you list - $7K - is not out of line with the closing costs on any mortgage, reverse or not. The balance of the loan does go up every month, but the people are benefiting by the extra money to spend now.
I first experienced a reverse mortgage with my paternal Grandmother, who really was house-poor. Very little cash, but she owned her house. The reverse mortgage gave her extra cash to spend while she was alive. When she died about 2 years ago, the heirs (my father and his siblings) were able to sell the house at a small profit, pay off the reverse mortgage, and split the remains among themselves. Everyone was very happy with the deal.
Which led to my parents thinking about doing the same thing. They’re both in their 70s, and although they are hardly poor, they’re not rolling in money either. They realized that they have maybe ten years left of active life, and they would like to spend some of their money on things like travel and their hobbies. They are very money savvy, and after doing a lot of research, ended up choosing a reverse mortgage as a way to get at the money invested in their home. I talked with them about it at length, and they also consulted a real estate lawyer. It was a very sound decision for them - they get to live in their (really nice) house for the rest of their lives, AND they get the money out of it to spend as they like. Does the bank make a profit? Sure it does. But why wouldn’t it? It’s providing a service, for a reasonable fee.
I don’t want to move this into GD territory, but can you please explain why this is? The bank makes money off of most of these deals; why does the government bail them out for the handful that lose money? Shouldn’t that just be a cost of doing business? This makes as much sense to me as the govt reimbursing a life insurance company when one of its insureds dies at age 30.
Athena- Financial difficulty is the only reason I’d recommend it. I have had people do it for other reasons such as purchasing a second vacation home. However, I wouldn’t bring it up as an option in that situation unless the customer did first. As my location indicates I’m in the Midwest, and I can’t speak with much authority on the closing costs elsewhere in the US but in my area $7,000 is about 5 times what you’d expect for a normal loan closing here.
You also have to go through extensive counseling to get approved, so most people prefer to go the easier route and save more of the equity for their children. But you are correct, there are some well off people who do reverse mortgages.
Opus1 My guess is that the government guarantees the loans so that banks will provide them. Look at it this way, aside from the initial closing costs the reverse mortgage doesn’t (usually) make the bank any money until the person dies. That means that while they are making money on paper the loan isn’t bringing the monthly interest income that the bank enjoys on every other loan it provides.
The bank isn’t an insurance company, and insurance companies either can’t, or aren’t in the business of doing mortgages. Even so, the statistics are still on the side of the government and the bank, and my guess is that an extremely small number of reverse mortgages end “upside down”
I made a slight error in the previous posts, the $7,000 figure that I used is only the amount of money that (my extra commission is based on as well as what) the bank gets as a servicing fee. But its far from the only fee, and I apologize for neglecting to mention all of them.
Reverse mortgages typically have the following fees:
Origination fee- typically 2% of the home(or loan amount), capped at $7,256
Closing costs - In addition to the origination fee, the normal closing and appriasial costs are tacked on, in my area they are usually between $900-$1400.
Mortgage Insurance Premium - This is the cost of insurance that the bank passes along to you in case the bank giving you the money defaults. This is another 2% of the homes value (or loan amount) again capped at $7256.00. But thats not all, theres an annual premium to provide this insurance, based on the value of the home, capped at $1815 per year.
Those are the upfront and immediate costs of the loan, so right away we have a potential cost of almost $16,000. But those aren’t the only costs…
In addition to the interest charged on the loan, (which is typically right around that of a conventional mortgage, right now 6.25-6.75%) There is also a $30-50 monthly servicing fee that the bank collects for providing maintenance on the loan.
So while your parents and grandparents may be enjoying extra piece of mind, I certainly wouldn’t recommend it from a purely financial perspective.
No, obviously it’s not an investment scheme!
But from what I have figured out, it’s not at all a bad way for people to enjoy the equity in their homes during their retirement. In my parent’s case, they had plenty of money for day-to-day stuff, but they wanted to be able to travel more, and that put a hitch in their finances. They figure they have ten more years to be able to comfortably travel before they get too old to drive and/or other physical ailments slow them down. They want to live their lives while they can, and the last thing on their minds is to leave cash to the kids. For them, it was a good deal.
I don’t know what their closing costs were. I do know that I’ve paid $5K-$7K in closing costs on just about every house I’ve purchased.
My grandmother was more the poverty issue; she had very little other than social security. The reverse mortgage gave her enough cash to be comfortable.
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