Geography plays key role in reverse mortgage loan limits

Imbalance exists between urban, rural areas
Tom Kelley

Wednesday, March 09, 2005

The increased loan ceilings on the nation's most popular reverse mortgage program will do little to help senior homeowners in many of Western Washington's rapidly appreciating neighborhoods.

That's because the Home Equity Conversion Mortgage (HECM), insured by the Federal Housing Administration, stipulates the single-family loan limit for the particular area where the home is located affects the size of reverse mortgage that a borrower can get. The FHA loan limit varies by county and typically changes annually in an attempt to keep pace with rising home prices.

The FHA loan ceilings are archaic and too broad. They do not help a homeowner with even a marginally expensive home in the countryside because loan ceilings are lower for non-metropolitan and rural areas and higher for higher-priced metropolitan areas. Some counties have FHA limits between these two extremes.

However, once the value of a home exceeds the FHA loan limit for the area, the size of the HECM can't get any larger. What would significantly improve the product is a single national limit, enabling homeowners with expensive homes in low-cost regions the ability to tap as much equity as those elders in high-cost areas of the country. The ability to borrow should not be curtailed by geographic location.

The common misperception of prospective borrowers is that they can qualify for a reverse mortgage equal or close in size to the value of their home, or at least the local FHA loan limit. This isn't the case. The actual loan amount will be equal to a smaller amount than these two figures (but still a substantial fraction of the home's value), in order to ensure that there will likely be sufficient equity left in the home when the loan comes due to assure full repayment.

A very rough rule of thumb to estimate your maximum reverse mortgage loan amount is to use your age, minus five years, as the percentage you can take from your net equity. For example, if you are a 75-year-old person with a $200,000 home owned free and clear in a mid-expense area of the country, the maximum reverse mortgage line of credit you could expect to receive would be $137,000 before closing costs. (Seventy percent – 75 minus 5 – of $200,000 is roughly $137,000). And, because of the complex formula of most of the reverse mortgage products, mom and dad probably will be unable to tap all of the equity in the family home anyway.

The size of a reverse mortgage is also affected by the type of loan chosen. In addition to the HECM, which accounted for 90 percent-95 percent of all reverse mortgages made in 2004, there are two other reverse mortgage products. One is the Fannie Mae Home Keeper loan. The other is Cash Account, a proprietary "jumbo" reverse mortgage product developed by Financial Freedom Senior Funding Corp., based in Irvine, Calif. The Cash Account is usually taken out on more expensive homes because it permits a much larger reverse mortgage than HECM or Home Keeper.

The borrower (minimum age 62) has several choices on how to take out the funds from a reverse mortgage. The proceeds can be taken as a lump sum, line of credit, fixed monthly payment or a combination. For most lines of credit, an added benefit is that the unused amount of the line of credit grows automatically each year based on a formula. In some cases, the credit line grows at a rate half a percentage point higher than the interest rate on the loan.

"Folks with million-dollar homes often have the same needs as those with lower home values," said Financial Freedom's Jim Mahoney. "They are taking the money and using it in ways they never thought they would because their incomes have been fixed - or perhaps falling with the performance of their stock portfolios. This is way very safe, secure way for seniors to stay in their home, continue to gain in the appreciation and pass on a nice estate to the heirs with the leftover equity.

"We believe our time has come. If you look at the fact that home values continue to increase in many parts of the country, this is great liquidity tool for seniors in their retirement planning, estate planning and just meeting their day-to-day cash needs."

The reverse mortgage industry has made positive strides, especially since 2002. The advent of the streamline refinance, ability to lock the expected interest rate at application or closing (whichever is lower) and the consumer protection requirement of a mandatory counseling before application all took place within an 18-month period.