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How recent reverse mortgage changes hurt most consumers

Reverse mortgage consumer protection

In October, 2017 FHA implemented some major changes to the rules for reverse mortgages. Some changes are good, but the price for those benefits for a few is very high for the majority of borrowers.

Keep in mind that most borrowers are financially challenged and turn to a reverse mortgage for relief from their cash flow struggles. The available loan is used pay off existing mortgages and provide a credit line for use in the future. Usually this credit line is there to subsidize a fixed income often strained to cover the borrower’s basic needs. This credit line has to last for the rest of their lives. For most, there is no other safety net. The importance of the amount of the available credit line cannot be overstated.

Here are the major changes to reverse mortgage rules

The upfront mortgage insurance is now 2% of the appraisal. Previous it was 2.5% for those needing more that 60% of the available loan at closing and .5% for others. So this helps some a little (.5%) and hurt others a lot (1.5%).

The annual mortgage insurance dropped from 1.25% to .5%. This is a huge savings for all. This is equivalent to your interest rate dropping .75%.

Now the maximum loan has dropped substantially in order for the lender to pay most or all of the borrower’s closing costs. Previously, it was usually easy for the lender to pay all the costs without it adversely impacting the loan.

Lastly, and most importantly, the available loan has generally dropped significantly. The loan has always been linked to the interest rate, but now the loan starts to erode for rates over 3% instead of over 5%. For example, if a 73 year old borrower previously was eligible for a loan of $250,000 at an interest rate of 5%, he is now qualified for:

  • 222,037 at 4.0%
  • 209,933 at 4.5%
  • 198,247 at 5.0%

Available loan is reduced significantly

As you can see, at 5% the borrower loses over $50,000 in available loan, or 20%. The lower rate take away less, but still a huge portion. We would all prefer a lower rate, but the priority of most borrowers is how much cash they is available in the future. Rate is usually secondary since there is no required mortgage payment at any rate. Also, the lower loan may be less than the existing mortgage so the borrower now does not qualify without bringing cash to the closing.

In summary, the borrower gets lower annual mortgage insurance and maybe lower upfront mortgage insurance, but they have to sacrifice a sizable chunk of the available loan and/or the lender paying for the closing costs. This is a tradeoff most cash starved borrowers would not choose.

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