The reverse mortgage marketplace has been through a rollercoaster in the past decade, as the number of loans grew by more than 100% from the mid-200s to the peak in 2009, only to fall by almost 50% in the years since then. While everything from the declining availability of home equity to more restrictive reverse mortgage rules have been blamed for the decline, it seems that in reality the primary factor has simply been the fact that reverse mortgages are more popular when "traditional" mortgage options are unavailable (e.g., in the depths of the financial crisis), and become less appealing as credit conditions improve.

Accordingly, this suggests that reverse mortgages may soon become even less popular as new rules just taking effect further reduce their availability, compounded further by a financial assessment that will begin to apply in early 2014, and the coincidental lapse of the FHA's "temporarily increased" maximum property value from $625,500 down to only $417,000 at the end of the year after 2014. The end result - reverse mortgages are facing their own "tightening credit conditions" during a time when traditional lending options have become more and more relaxed - which may mean clients and their planners are less interested than ever in considering a reverse mortgage, even while reverse mortgage strategies like the standby line-of-credit or refinancing a forward mortgage into a reverse remain as valid as ever.

For those who are interested in a prospective reverse mortgage, though, the time may be now to act, as the tighter limits taking effect in 2014 means that clients may never again be able to borrow as much on a reverse mortgage as they can through the end of December. Even for those below the FHA property limits and who won't otherwise be affected by the changes taking effect next year, the simple fact that reverse mortgage borrowing limits decline by approximately 20% for every 100 basis point increase in interest rates means that there may be no better time than right now to get a reverse mortgage line of credit in place. In the long run, though, it remains unclear whether the reverse mortgage industry will be able to weather the storm it faces as reverse mortgages become relatively less appealing compared to available alternatives, or whether reverse mortgages will simply remain used in limited situations as a loan of last resort (to the extent still possible), or simply for older clients who advanced age still allows for more useful higher borrowing limits.

Wednesday, December 4th, 2013 Posted by Michael Kitces in Debt & Liabilities | 0 Comments

While the current low-yield environment has presented significant challenges to retirees trying to generate retirement income, the upside is that low yields have also driven down borrowing costs to record lows. As a result, retirees are increasingly deciding that perhaps keeping a mortgage and not paying it off is a good idea after all; with the average long-term return on stocks being significantly higher than today's 30-year mortgage rates, an inexpensive mortgage becomes a strategy to leverage the household balance sheet and boost the amount and sustainability of retirement income.

Yet the decision to keep a mortgage in retirement is not without risk. There's a danger than equities won't perform as expected, and fail to generate a return in excess of the borrowing cost over a relevant time period. And even if the returns do ultimately add up, the ongoing payment obligations for a traditional mortgage create a "sequence of returns" risk for the retiree, where withdrawals to handle the mortgage payments could so deplete the portfolio during an extended period of bad returns that there may not be enough money left over for when the good returns finally arrive.

From this perspective, retirees should perhaps consider the reverse mortgage instead. While such loans have been relatively unpopular - due in part to their high costs, and because they're often viewed as a borrowing option of last resort - the reality is that the lack of any cash flow obligations for a reverse mortgage actually allows it to eliminate the sequence risk from the mortgage-in-retirement strategy. In fact, over a long period of time, using a reverse mortgage in retirement can result in materially greater wealth when equities do perform as desired, as the reverse mortgage maintains a greater amount of household leverage, even while reducing the exposure to the impact of an unfavorable sequence of returns.

In the end, there are still a few caveats to the strategy - most notably, that reverse mortgages still tend to have higher upfront and ongoing borrowing costs (though the gap is narrowing), and that lending limits may constrain the usefulness of the strategy for affluent clients (who are often most interested in increasing household leverage as a retirement strategy). Nonetheless, the fact remains that for those who truly do wish to engage in the mortgage-in-retirement strategy, the reverse mortgage may be the most effective way to execute it.

Wednesday, September 18th, 2013 Posted by Michael Kitces in Debt & Liabilities | 7 Comments

In the aftermath of the financial crisis, the decline of real estate prices has been a distress not only to traditional mortgage borrowers and lenders, but also the Federal Housing Administration (FHA) and its reverse mortgage program. As a result, the Department of Housing and Urban Development (HUD) has taken several steps to make the program somewhat more restrictive, reducing borrowing limits and increasing the insurance premiums to borrowers that back the program.

In a big announcement this month, HUD has announced a new round of changes that will consolidate HECM Saver and Standard loans, change the principal limits that impact the maximum consumers can borrow, and generally increase costs once again for reverse mortgages. In addition, the HECM reverse mortgage program will become much more restrictive in how much can be borrowed at once, and early next year will introduce a new financial assessment process to further ensure that reverse mortgage borrowers have the means to maintain their property taxes and insurance to avoid defaulting on the loan.

From the financial planning perspective, these changes are arguably a good step to help curtail some irresponsible borrowing, and ironically may have little impact to the clients of financial planners who already tend to be somewhat more affluent and more proactive in their retirement strategies (while the impact will be more significant for those already in dire financial straits). On the other hand, the new higher costs for many types of loan approaches, and the new limitations on principal limits - which can be particularly constraining to affluent individuals with pricier homes - may make reverse mortgages somewhat less appealing for financial planners, even as the reverse mortgage industry shifts to focus more on the types of clients that planners typically work with.

Wednesday, September 11th, 2013 Posted by Michael Kitces in Debt & Liabilities | 2 Comments

On January 30th, the Department of Housing and Urban Development (HUD) issued Mortgagee Letter 2013-01, which announced that beginning April 1, 2013, reverse mortgage borrowers will no longer be able to obtain a fixed rate on HECM Standard reverse mortgages; instead, only the HECM Saver loans, with smaller loan limits, will be available with a fixed rate option. Those who wish to borrow a lump sum using a HECM Standard reverse mortgage in the future will be required to select an adjustable rate structure, just as they must do now under either the monthly income or line-of-credit payment options.

While the change is significant to the reverse mortgage industry, given that a large and rising percentage of reverse mortgages in recent years have been established under the fixed-rate structure, from the planning perspective the impact is likely to be more limited, as many planners have only recently begun to consider reverse mortgages for clients when the less expensive HECM Saver loan became available (and which can still be done with a fixed-rate structure). In addition, many reverse mortgage strategies - including some highlighted in recent years in the Journal of Financial Planning and The Kitces Report - are based upon the monthly income or line-of-credit payment options, which require an adjustable interest rate loan structure anyway.

Perhaps the greatest irony of the HUD change, though, is its reported reasoning: a rise in defaults by fixed-rate borrowers who extracted the maximum equity from their home, found it wasn't enough, and subsequently began to fail making their property tax and homeowner's insurance payments, triggering a reverse mortgage default. In other words, HUD is finding that it's very problematic when consumers use reverse mortgages as an income-of-last-resort solution, instead of engaging in the reverse mortgage earlier as an income source coordinated as a part of the individual's overall financial plan - guidance that would perhaps be more useful to both consumers, and financial planners too!

Wednesday, February 27th, 2013 Posted by Michael Kitces in Debt & Liabilities | 9 Comments

In the ongoing difficult borrowing environment, some potential homebuyers have found the best way to finance a purchase is not from a major commercial bank, but from the "family bank" instead through an intra-family loan. And as long as IRS guidelines are followed, the transaction can be remarkably appealing, with more flexible lending terms, IRS-required Applicable Federal Rates that are still lower than commercial mortgage rates, the potential to still deduct mortgage interest payments for the borrower, avoidance of origination and many other mortgage transaction fees, and the simple benefit that all the interest and principal payments ultimately stay in the family. A major downside, however, is that to ensure the IRS truly respects the transaction - and to receive some of the tax benefits as well - formalities of the loan should be honored, including drafting a promissory note, recording the mortgage against the residence in the proper jurisdiction, and completing actual payments of interest and/or principal. Fortunately, a new solution has emerged - a company called National Family Mortgage, that completes all of the required documentation, records the mortgage, helps to service the loan, and even issues the requisite IRS reporting forms, all for a fraction of the cost of a traditional mortgage loan origination fee. While this won't likely mark a great boom in intra-family mortgage lending, it nonetheless makes the strategy far easier for advisors to implement efficiently for clients!

Wednesday, January 23rd, 2013 Posted by Michael Kitces in Debt & Liabilities | 3 Comments

Planners have long recommended that clients save and invest, even while they have a mortgage, since the long-term return on equities generally exceeds the interest rate on a mortgage. Yet in reality, investors don't simply choose to invest in equities because the return is higher than a fixed alternative; instead, investors demand an equity risk premium over and above the risk-free rate to make equity investing worthwhile. For the traditional investor, the equity risk premium has represented the excess return of stocks over long-term government bonds. Yet for the mortgage borrower, the available "risk-free return" isn't just a government bond, but to prepay the mortgage and eliminate the interest cost! As a result, while the investor looks for an equity risk premium over government bonds paying 2%, the mortgage borrower actually shouldn't invest in stocks unless there's an expectation to earn an equity risk premium over a mortgage interest rate that might be 4% to 5%! Consequently, clients should prepay their mortgages unless they expect a full 9%-10%+ return on equities in the current environment that sufficiently rewards them for the risk!

Wednesday, May 2nd, 2012 Posted by Michael Kitces in Debt & Liabilities | 34 Comments

In December, Congress passed the Temporary Payroll Tax Cut Continuation Act of 2011, which extended the 2 percentage point payroll tax "holiday" of 2011 into the first two months of 2012. However, to offset the nearly $20 billion cost of the payroll tax cut extension (along with a few other provisions), Congress adjusted the so-called guarantee fee charged by Fannie Mae, Freddie Mac, and the FHA, mandating that the fee must rise by at least 10 basis points. The new g-fee increase is set to apply beginning on April 1, 2012 (no fooling!), and its effects are already being felt as borrowers look to set 45- and 60-day rate lock guarantees on current purchases and refinances. The net impact to clients: if there's a purchase or refinance being considered, it could be worth many thousands of dollars to get the loan done as soon as possible.

Tuesday, February 7th, 2012 Posted by Michael Kitces in Debt & Liabilities | 2 Comments

Clients who need to improve their prospects for retirement generally have three options: spend less, save more, or retire later. Technically, there is a 4th option - grow faster - but it is typically dismissed due to the risk involved in investing for a higher return. In practice, clients rarely seem to dial up the portfolio risk trying to bridge a financial shortfall in retirement, and taking out a margin loan just to leverage the portfolio to achieve retirement success would most assuredly be deemed imprudent and excessively risky. Yet at the same time, a common recommendation for accumulators trying to bridge the gap is to keep any existing mortgages in place as long as possible, directing available cash flow to the investment portfolio, and giving the client the opportunity to earn the "risk arbitrage" return between the growth on investments and the cost of mortgage interest. There's just one problem: from the perspective of the client's balance sheet, buying stocks on margin and buying stocks "on mortgage" represent the same risk and the same leverage, even though our advice differs. Are we giving advice that contradicts ourselves?

Monday, October 24th, 2011 Posted by Michael Kitces in Debt & Liabilities | 34 Comments

Borrowing money to invest is a risky thing for individuals to do. While it's a common path for businesses - borrowing money to plow into investments, infrastructure, staff, expansion, etc. - it is done in part because business structures allow for limited liability; in other words, we often borrow in business specifically because the debts cannot track back to business owners the way individual borrowing can. Accordingly, for most individuals, the only major debt that is taken at all is a mortgage to purchase a house, and only because that's a "long term" investment (and because we couldn't afford a house any other way); most other forms of individual debt are considered "bad" debt and only used as a necessity to be paid off quickly (e.g., credit cards or auto loans). As a result of these attitudes about debt, I'm not certain I have ever seen a financial planner tell a client "since you're low on cash flow right now, you should take out a loan so you can have money to buy stocks in your 401(k) this year." Tax deferral on retirement contributions aside, it's just viewed as too risky by most to borrow money just to invest in equities in a typical investment account. There's just one problem... by telling clients to keep their mortgages as long as possible while building their retirement accounts, we're doing the exact the same thing: telling clients to invest in the stock market by borrowing. 

Monday, September 26th, 2011 Posted by Michael Kitces in Debt & Liabilities | 10 Comments

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