Lending from your SDIRA - Reverse Mortgages
By: im Jones - Business Development Manager for The Entrust Group - Massachusetts
IRA & 401(k) Insights
The reverse mortgage industry prides itself as the lenders of the Good Mortgage: the mortgage for senior homeowners that not only provides essential retirement funds but also the mortgage that comes to the rescue, preventing foreclosures by paying off old “forward mortgages,” delinquent property taxes, and unpaid insurance bills. Senior homeowners can tap the equity to stay in their home.
Reverse Mortgages have been around in various forms for 50 years, but the overwhelming majority has been the FHA Home Equity Conversion Mortgage. From the HECM program’s inception in 1990 until 2008, the program grew slowly from 157 loans in its first year to a mere 6,600 loans in 2000, but then grew rapidly, with a record of over 112,000 loans originated in FY 2008. Year after year, FHA reaped the benefit of collecting an ever-growing amount of upfront Mortgage Insurance Premiums (up to a whopping $12,510 upfront at closing, in addition to other fees). But beginning in 2008, that trend reversed abruptly: The HECM program’s profit (or negative subsidy) declined to $462 million in FY 2008.
FHA’s recent announcement that the HECM program is expected to lose over $800 million in FY 2010 has exposed a weakness in this relatively small but rapidly growing sector. The trouble with HECM is that the program encourages senior homeowners to borrow a very high percentage of their home value (a 72 year-old HECM borrower can receive as much as 71% of the value of their home, in an upfront lump sum if they wish, an 80 year-old qualifies for a 78% LTV loan and a 90 year-old 86%.), which not only increases FHA’s losses, but also unnecessarily drives up costs to borrowers, lenders and investors. The lack of a more efficient, low-cost alternative has also discouraged many senior borrowers who might otherwise benefit from a HECM loan, but are discouraged by the size of the upfront fees which can total over $20,000.
The HECM program began at the dawn of a great bull market in residential real estate. From the year of the program’s inception in 1990 to 2006, home prices rose at an average of about 6% per year, outpacing the historical average of 4%. With such rapid home appreciation, it’s easy to see why the HECM program was so profitable. An average loan will take 19 years to reach “break-even equity” starting at 70% LTV, 27 years starting at 60% LTV, and so on. It is important to note the average life span of a HECM loan is about 9 years.
However, reverse that trend and the numbers change dramatically: without home price appreciation, the 80%, 70%, and 60% LTV loans reach “break-even equity” in about 4, 7, and 8 years. Needless to say, if home prices continue to decline, the homeowner’s equity is wiped out very quickly.
The further trouble with reverse mortgages goes beyond a factored 4% annual home price appreciation requirement. The loan amount to a great degree is based on the borrower’s age, or really their life expectancy which utilize the life insurance industry’s actuarial tables. These continue to change every few years to factor advances in health care and longer lives. Therefore, this concept of an “open-ended” loan no longer is a sure bet. As a result, the two biggest lenders in reverse mortgages, Bank of America and Wells Fargo have exited the business completely.
The irony is that the demand for reverse mortgages is exploding. Trends show the baby boomers starting to retire have saved less than previous generations, have been seriously hurt in their retirement accounts from the stock market’s losses in 2000, 2007 and 2009, and are facing a significant real estate collapse and cannot or do not want to sell their homes at present.
There are a few private organizations beginning to offer SELOC’s, or Senior Lines of Credit. They are basically a home equity loan secured by the property for a definitive period of time, typically 10 years. While AARP quotes 86% of seniors want to stay in their own home, it is also statistically true that by age 82 the average senior homeowner can no longer live safely at home. The idea is that a SELOC will give a senior homeowner time to enjoy a good part of their retirement in their beloved home, while having an exit strategy at some point for alternative living accommodations.
The opportunity therefore, is for owners of self-directed IRA’s to offer these types of reverse mortgages or SELOC’s.
Qualifying would not be based upon their age nor credit score as the loan is secured by the home, so the IRA investor does not have to worry about credit scores and other credit worthy calculations. Nor does the investor have to worry about collecting monthly payments as that would defeat the purpose of the loan. The loan amount would be based upon some realistic calculation including paying off any existing loans or tax liens, medical expenses, or shortfall in income living expenses as opposed to the HECM which allows for no restrictions on frivolous purchases or even bad investments or scams.
Interest rates could be set at a premium to the market in line with other private money rates as this would be a non-conventional loan. In addition, a HECM charges at least 4 points at origination (2 for PMI and 2 for origination), so anything less than 4 points would be competitive. Lastly, as repayment is secured by the property and by a definitive date and definitive action (typically selling the house), risk or default is minimized greatly. As in a HECM, there would be default terms for nonpayment of property taxes or negligent home care, death or permanently leaving the home, as in going to a nursing home.
Lastly of course, is an immeasurable facet that goes beyond an investment that offers a healthy return on minimal risk. Having personally been in the reverse mortgage business, there is nothing quite so satisfying as sitting at the closing table and watching someone’s mom cry, and hug you, and give you a homemade pie because you gave them a solution to stay in their home full of fond memories until they are ready to leave with dignity and on their own terms.
By Jim Jones
Jim Jones is a Business Development Manager for The Entrust Group - Massachusetts, a premier provider of self-directed retirement plans. He can be reached at JJones@TheEntrustGroup.com or 617-454-1085.
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