Are you falling short on your financial goals for your retirement? If you own your own home, do you know the value of the equity you have in it?
In this episode, Marc Bautis brings on a longtime friend to discuss reverse mortgages and how they may be of benefit to your financial plan. David Faccone is a mortgage lender from Finance of America with vast knowledge and experience with these types of mortgages.
In this episode, you will learn:
- What exactly is a reverse mortgage
- Who is eligible to apply for a reverse mortgage
- The pros and cons to having a reverse mortgage
- And more!
Tune in to find out what options you have when using your home to aid you in retirement.
Aric: I’m excited today because you’re talking about reverse mortgages and before the podcast we were talking a little bit. One of my family members utilized a reverse mortgage to help them out and it went very very well. It was a little scary at first because we didn’t know a lot about reverse mortgages. We did a ton of research and it was really, really good for his situation. I’m excited to learn more about what you are gonna be talking about today.
Marc: Today we’re going to talk with Dave Faccone who is a mortgage lender from Finance of America. Dave welcome to the show.
Dave: Thanks for having me Marc.
Marc: Aric, we didn’t talk about this but I’ve known Dave for many years. We actually played on the same Babe Ruth baseball team and grew up in the same town. We brought Dave on the show to talk about reverse mortgages. It’s a topic I’ve wanted to discuss on here for a while. I’m seeing more and more during retirement income planning where retirees are falling short of having enough money in retirement. Less people have pensions. They may not have enough saved enough 401K or their IRA. They may do things like overestimate how much they’ll receive in Social Security or underestimate how much they’ll have to pay for things like taxes and health care expenses. But then we go through all of the different assets they have and we see that they have a lot of equity built up in their house. Utilizing a reverse mortgages is one way to access that equity. Dave, to get started can you give an overview of what a reverse mortgage is?
Dave: During the podcast you will probably hear me compare reverse to traditional mortgages a lot because that’s what most people are familiar with. In the simplest terms a reverse mortgage is a loan that is secured by a home but the payment is deferred to a later date. Unlike a traditional mortgage where you you close the loan, you move into the home and you are making a customary monthly payments that reduces the loan amount with a reverse mortgage you don’t have to make those monthly payments. You just have to pay the loan off sometime in the future. The reason for the word reverse being is really two reasons.
First and foremost, the money flows in reverse. If you utilize the equity in your home, you have the choice of taking an initial lump sum payment at closing or initial monthly payments. And in this case the cash is coming from the equity in the house and it’s going right into your pocket which is reverse of a traditional mortgage where you typically send monthly payments to the lender to pay off your balance. The second reason for the word reverse being used is that the loan balance goes in reverse as well. Unlike again with the traditional mortgage making monthly payments and the loan balance decreasing month to month with a reverse mortgage you don’t have any obligation to make a payment. The loan balance actually increases over time.
Marc: In the intro we talked a little about reverse mortgages being a good solution for retirement income, but what are some other common uses of reverse mortgages?
Dave: First and foremost the biggest common misconception about a reverse mortgage is that the homeowner is desperate that they need money. They have an immediate need they don’t have cash in the bank. They don’t have investments that they can cash out or liquidate. And that could be true but it’s not altogether true because there are other common uses of the reverse mortgage product.
Common Uses of Reverse Mortgages
- You could have an immediate need for cash. Like I said let’s say you need repairs done to your home or you have maybe medical expenses that were unforeseen. You could use the equity from your home in a reverse mortgage loan to cover those expenses or as
- Some people choose to use the reverse for to enhance their lifestyle. They aren’t cash poor but maybe they just want to travel more. Or maybe they want to put an addition on their house that they’ve been postponing for a while or they want to make a large purchase like a new car or a boat.
- Another good reason or good use to get the reverse mortgage finally as you would know Marc. It could be part of a person’s financial plan. There could be tax benefits to using equity from your home as opposed to using other retirement savings or retirement income or part of the financial planning.
- It can simply be an emergency fund or a rainy day fund. You can originate the reverse mortgage and you don’t necessarily have to draw on it until you need it.
It used to be where we would never consider the primary residence as an asset as part of the retirement plan because we would always think that the person needs somewhere to live. To utilize the home equity they would have to downsize, sell the house and move. They then could use the sale proceeds to generate retirement income. Not everyone wants to move or wants to downsize. But if you incorporate a reverse mortgage into the plan they can get the best of both options as they can tap the equity as well as stay in the house
What are the eligibility requirements for a reverse mortgage?
Dave: Age is probably the biggest factor and the first factor that lenders look at when determining eligibility. Typically a borrower has to be at least 62 years of age and lenders do round your age. So in other words if you are sixty one in seven months we will round up to 62. We do allow more than one borrower on the application for a reverse mortgage. So if it is a husband and wife situation then we would need the youngest borrower to be at least 62 years old. There are some caveats where possibly we could reduce the equity available in the reverse mortgage. If you have a spouse who is below 62 we would clarify them as a what we call a non borrowing spouse. So even though they exist, they may not be on the application. We don’t need to go into detail about that right now but just just so that listeners know 62 is really the hot button. If you’re 62 or above then you do have eligibility to get your equity in the reverse. The second qualification or necessary guideline for eligibility is occupancy. Reverse mortgages are only lent on homes that you occupy. If you own an investment property or you own a second home or vacation home those properties unfortunately will not qualify for the reverse mortgage. It has to be a home that you live in. Property type is also a consideration, although you’re not really pigeonholed too much because reverse mortgages are allowed on any single family property. They are allowed on two to four unit properties that again have to be occupied by the borrower. You can live in a multi unit property as long as it’s four units or less and still qualify even if you live in a condominium or townhouse And finally the last piece that I want to discuss regarding eligibility. This isn’t a requirement per say but if you have a large amount of equity in the property it definitely helps because then you can have access to the most amount of funds that you’re looking for.
Obligations once someone takes out a reverse mortgage
Dave: There are actually a couple of obligations that are required when you do originate a reverse mortgage.
- The first of the obligations are right at closing. So when you do close that the reverse mortgage loan you’re obligated to pay any underlying traditional mortgages that may be that may exist on the property already. There is a title search involved in closing a reverse mortgage just like in a traditional mortgage. So if the title search discovers any liens or any judgments that are on title. Those would also be have to also have to be paid at closing as well on their certain amount of closing costs that are paid a closing of course and initial mortgage insurance premiums so reverse mortgages come not only with an initial mortgage insurance premium at closing but there’s also annual mortgage insurance which accumulates on the balance if if you don’t make any monthly payments.
- Once you close on the loan you’re obligated to treat the home like you’ve done in the past. If you had a traditional mortgage or if you owned the home for cash you know traditional obligations are
- Pay your property taxes quarterly
- Pay your homeowner’s insurance premiums.
- If you live in a flood zone then you may have to pay flood insurance
- If you are in a condominium or townhouse for instance you’re still obligated to pay your homeowner’s association fees and maintenance
- The other one of the biggest obligations that really isn’t a financial obligation, but it is to continue to occupy the property. So like I said earlier one of the guidelines for approval is this has to be your primary residence. So once a year you’ll receive a document attesting to the fact that you do in fact still occupy the property and that will be sent back to the lender to confirm that it is still your primary residence.
- The other thing that I failed to mention actually closing there could be some obligations to pay property taxes or homeowner’s insurance premiums either at closing or sometimes within the first year of closing so we actually may put aside some funds after closing to pay taxes or homeowner’s insurance on your behalf as well.
Marc: I think we wanted to discuss some of the features of the reverse mortgage. I think it’s one of the most misunderstood financial products that I’ve come across. The first one I want to start with was the fact that it’s a nonrecourse loan.
Can you talk about what happens if for example the the mortgage debt accrues beyond the home value. One concern I see from people is whether their heirs be responsible for any debt that accrues with the mortgage.
Dave: Non-recourse means that the home is responsible for paying off the debt. The homeowner nor the heirs of the homeowner are responsible. To that end non recourse means that no one will ever owe more than the property is valued at. Depending on how long you’ve had the reverse mortgage how many years fees have accumulated: in terms of mortgage insurance premiums and interest that gets accumulated over time. It also depends on the appreciation or depreciation of the property. If you ever get to the point where the reverse mortgage balance exceeds the value of the property then that’s where the mortgage insurance that you’ve paid at closing in over time comes into play. If the homeowner decides that they no longer want to reside in the house and they want to move to a different property and they sell the property. The mortgage insurance kicks in. They’ll never be responsible for more than 95 percent of the value of the property at any given time. The mortgage insurance would pick up the rest. So no one’s walking away from the property (either the homeowner or their heirs selling it) and being stuck with a bill. That just won’t happen.
Marc: That gives the homeowner some peace of mind that like you said no one’s gonna be stuck with the bill when it gets when it gets sold.
How does someone know how much they could expect to receive by taking out a reverse mortgage?
Dave: The principal limit is calculated based on two factors. Its based on the age of the borrower. And it’s also based on expected interest rates going forward into the future.
There are charts that exist for through FHA where it will show exactly what these ratios are. You can literally look at your age if you’re 62 years old and you just begin to qualify for a reverse mortgage. Then you can go across the chart see what today’s prevailing interest rate is. That will give you a percentage. I don’t have that chart in front of me but let’s just say that the percentage was 50 percent. After an appraisal we can see what the value of the property is. The reverse mortgage would allow you to borrow up to 50 percent of the value of the home. And again that number is based on the age of the youngest borrower and expected interest rates going forward into the future.
Marc: It sounds similar to how Social Security or an annuity works where the longer you wait to to collect on in this case take out a reverse mortgage the bigger the draw you would receive.
Let’s say someone wants to move forward with a reverse mortgage. What payout options do they have in terms of accessing that that cash that’s available to them?
Dave: There are really two main payout options. So again comparing it to a traditional mortgage when you go to purchase a home with a traditional mortgage. The two main options are you can choose are fixed rate or you can choose an adjustable rate and a reverse mortgage loan is no different. If you decide that you want the peace of mind of a fixed rate then that’s what you can choose. The rate will never change over time. The caveat to that is you receive one lump sum payment. After closing it we determine what the limit is that you can borrow. You tell the lender exactly how much you want to walk away from closing within and then you receive one lump sum payment. The loan balance begins after closing and starts to accumulate your interest and mortgage insurance over time. However, the interest that accrues will never change.
The second payment option is an adjustable rate where the rate could actually change either monthly or annually depending on the product and term you choose. You have the option of getting an initial disbursement after closing with the adjustable rate and then you also have an open line of credit that goes forward and continues into the future. If you decide you want the initial disbursement at closing that great. Alternatively if you have some remaining limit in the future and you want to withdraw from that going forward you always have that option and the rates could change either monthly or annually whichever you choose.
Marc: The line of credit seems more like a credit card or a home equity line where if they need they need it, they can use it. They only pay on what they use.
Dave: Absolutely. And as long as you retain some sort of outstanding balance even as low as one hundred dollars balance in the line of credit then that remains open. So you’re absolutely right. You’re only going to be charged the interest on whatever you withdraw on the adjustable rate. And just to be clear, even though I said that there are no required monthly payments. Reverse mortgages do allow you to make payments if you want to. So whether it be the fixed rate option or the adjustable rate option if you have extra cash and it fits into your financial plan you can always send in payments and those payments first and foremost go to pay off the mortgage insurance premiums. Then interest fees. And finally when all the fees are paid then whatever is remaining from that payment will reduce the principal balance. You can think of the adjustable rate option similar to a traditional line of credit where you can use it and pay it as long as you like.
Marc: What happens to the home after death?
Dave: Let’s back up a second because the reverse mortgage becomes due and payable when the last borrower no longer occupies the home and of course that could be caused by the last borrowers death. If the borrowers decide to move out. or if they pass away then the heirs have a decision to make.
There are really two decisions. First and foremost do the heirs want to keep the property? If they want to keep the property and there is equity in the home the heirs can choose to refinance and and keep it in their own name. If they are less than 62 years of age then they would have to refinance with a traditional mortgage. If they want to keep it and there is no equity in the home meaning the reverse mortgage balance has now exceeded the value then because of the non-recourse feature like we discussed, the heirs would have to pay off 95 percent of the home’s value and then they would keep the property.
if the heirs didn’t want to keep the property at all. There are also two options. So again the first option if there’s equity in the home they could simply sell it like they would any other home and pay off the loan balance that’s outstanding on the reverse mortgage. If they owe the balance of $100,000 and the house sells for $200,000. The heirs would walk away with an extra $100,000 in their pocket if there was no equity and the heirs did not want to keep the property then they would simply sign over a deed in lieu of foreclosure which means they’re just essentially handing the ownership of the property back to the lender and the lender will do with it as they please.
Marc: To summarize it looks like it comes down to two things. One is there equity left in the house. Secondly, do they want to keep the home and based off of that the combination of those answers to those two questions that would dictate what their options are.
Can you go over what the process is of obtaining a reverse mortgage?
Dave: In order to obtain a reverse mortgage the first thing you need to do is have a discussion with a lender like myself. In that discussion we will review the options that we discussed previously here on the podcast. We’ll talk about how old are you and what do the mortgage rates look like today. What type of limit can you qualify for. How long are you planning on living in the property. All the things to see if it actually meets your immediate needs whether you need cash now or you’re just planning your financial future with someone like Marc. Then the lender would provide you with what we call a pre counselling package. In that package you get a list of of loan counselors that are in your area. A reverse mortgage requires that the borrowers do speak to a loan counselor and they are a second opinion and double check the fact that the decision you are making is correct.
We’ll also provide you with initial disclosures just like you would with any other traditional mortgage. And if you decide that after counseling that the reverse mortgage could be right for you we complete a loan application similar to a traditional mortgage and order an appraisal to see what the value of the property is. The loan would get processed and then it would be serviced just like we would with any other mortgage where you will get regular regular monthly statements that show you what the loan balance is. If it’s a fixed rate obviously that’ll be great I’ll never change but if it’s adjustable then you may be more inclined to look at that statement to see if the rates are going up and down month to month or year to year. We would be there for you going forward if you ever decide to make another change on the reverse mortgage.
What are some of the reasons why a reverse mortgage may not be a good fit for someone?
Dave: The first reason is if the plan for occupancy of the home is either uncertain or if they have a plan to leave the home in the near future. There are closing fees involved in originating the loan in the first place so if you use the reverse mortgage as a long term financial solution or rainy day fund for instance then spreading out those costs over time becomes very cost effective and the benefit becomes much greater. If on the other hand you originated the loan you accumulate the closing fees and in a short amount of time (1-2 years) you decide that the home is no longer right for you. The cost per year to originate that loan becomes much higher and the benefit is greatly reduced. That’s the first reason why you shouldn’t do it.
Secondly and this may seem obvious but you shouldn’t originate a reverse mortgage if there’s no no tangible benefit to you. Let’s say that you qualified for one but you didn’t have a heck of a lot of equity in the house and you wanted to use it for an emergency fund going forward. If your equity is low and the limit that you can qualify for it is not a heck of a lot of money. Why would you pay the costs involved in doing that just wouldn’t make sense?
Thirdly you also might be a little obvious if you don’t understand how it works. I think we’re here today in the podcast to educate Marc’s clients and our audience so they maybe get a better understanding of the options they have with reverse mortgages. But if you’re someone who was signing on the dotted line, but you really don’t know what you’re getting into then that’s probably not not a good decision for you and you should go back to your lender, go back to your counselor until you really get a grasp of what the loan entails.
Finally the last reason why it may not be a good idea is if your desire for your home’s equity or value is to protect the legacy of your family or the inheritance to your heirs. If you simply don’t want to touch the equity in your home and you want to leave an asset for your family after you’re no longer with us then you may want to consider other options as well.
Marc: Those are some reasons why it may not be a good option but there are a lot of reasons why it may make sense and this is another tool that as a planner we can use to help someone achieve their goals in retirement or help achieve their estate planning goals.
We are just about out of time. Dave, thank you for being on the show today. How best can someone reach you if they want to get a hold of you?
Dave: Thanks for having me today Marc. I really enjoyed myself. You can reach me directly on my cell phone 201-334-7067. Or you can always send me an email at [email protected]. Or you can visit my website davidfaccone.com
Aric: Guys thank you so much. This was a fantastic podcast. David you are a great guest. I learned a ton more than I than I knew from before. And obviously you’ve been in this business for a very long time and that’s exactly why Marc brought you on. I’d like to hear some more stories from Babe Ruth baseball but that’ll be for another podcast right. This may be something that somebody needs to hear right now. There’s all sorts of reasons to do it just like David explained. But maybe somebody needs a little help with it. This is a great one to share so they can get in contact with them again. Thanks for listening today for everyone at Bautis Financial this is Aric Johnson reminding you to live your best day everyday. We’ll see you next time.