How new reverse mortgage rules affect retirement plans

The federal government has clamped down on reverse mortgages, issuing a new set of rules that make some loan amounts smaller, fees higher, and drawdowns less flexible.

What will the changes mean from a retirement-planning perspective? We’ll get to that in a moment. But first, here are some basics on reverse mortgages.

Reverse mortgages allow seniors to turn their home equity into cash while staying in their homes. Unlike a forward mortgage, where you use income to pay down debt and increase equity, a reverse mortgage pays out the equity in your home as cash; your debt level rises and equity decreases.

The most popular loan type is the home equity conversion mortgage, which is administered, insured, and regulated by the U.S. Department of Housing and Urban Development. HECMs are different than traditional home equity lines of credit in that repayment of a reverse mortgage typically isn’t due until the homeowner sells the property or dies.

New Rules

The new rules govern HECMs, and the changes followed congressional action taken over the summer to address the problem of rising loan defaults, which pose risk for the Federal Housing Administration insurance fund, which backstops the loans.

Homeowners age 62 or older can qualify for HECMs if they have sufficient equity in their property. The amounts that you can borrow are determined by a formula that takes into account the percentage of the home’s value, your age, and prevailing interest rates.

As mentioned above, HECMs don’t have to be paid back until you move out of your home or pass away. But defaults are possible because the loan terms require homeowners to continue paying property taxes, hazard insurance, and any required maintenance on the property.

Reverse mortgages would never be my first choice in funding retirement because it’s a form of debt–and the HUD reforms make them more expensive to use. But home equity is one of the most important assets on the balance sheets of most older Americans, and many will need to tap it in retirement. In that context, the recent changes to the HECM program are a step in the right direction because they aim to make the loans safer and encourage loan usage as a long-term financial-planning tool, rather than as a disaster-recovery tool for households already facing significant financial stress.

What’s more, the changes in net loan proceeds are minor. Here’s a rundown of what’s changed in the HECM program:

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