Tom Kelly: Reverse mortgage ‘subordination’ clarified

A few months ago, we addressed the topic of encouraging borrowers to ask their lenders “what’s possible” in recasting their home loans. Some consumers who have owed more than their home was worth have been able to get their prepayment penalties waived when attempting to refinance to more affordable rates and terms.

We also supported seniors who approached their lenders about “subordinating” their loans to allow them to obtain a reverse mortgage. By doing so, the senior is able to remain in the home when they otherwise would have been forced to move.

We offered an example that drew questions, comments and concerns from reverse mortgage lenders. While the office of the Federal Housing Commissioner issued a mortgagee letter to all reverse mortgage lenders attempting to clarify the subordination rules for home equity conversion mortgages, or HECMs, some lenders wrote to us believing no secondary liens are permitted on reverse mortgages. Others say existing liens, yet no new liens, are allowed.

Our case involved an 81-year-old couple who took out a second mortgage two years ago to help their daughter buy a home. The daughter agreed to make the payments on the loan. Unfortunately, she lost her job and was no longer able to make the monthly payments. As a result, the homeowners became delinquent on both their first mortgage and their second mortgage. They subsequently received a notice of foreclosure on their first mortgage.

The couple inquired about a reverse mortgage. The only way it could work was to have the lender with the second mortgage agree to subordinate or “remain in second place” in the lien line.

While it is rare for a lender with a second lien on a property to agree to “remain in second place” by allowing a new loan – especially a reverse mortgage – to take over the first lien position, the couple had been longtime customers and needed the help to make the deal work.

Here’s how the reverse mortgage solved the dilemma: The couple’s home value was $235,000 and encumbered by a first mortgage in the amount of $140,000 and a second mortgage of $60,000. After fees, the couple was eligible for a reverse mortgage of $171,000. When the reverse mortgage closed, the first mortgage was paid off and the remaining $31,000 brought the second mortgage current and also bought down a significant portion of the balance.

Some reverse mortgage lenders claim the scenario differs from what the commissioner’s letter addresses. The borrowers did not obtain new subordinate financing in order to make the reverse mortgage work. In this case, the second lien holder executed a subordination agreement, agreeing to take a subordinate position to the first and second liens created by the HECM.

While it is prohibited for a borrower to obtain subordinate financing as part of the transaction, in this case the transaction was permissible because it was an existing lien holder who agreed to a subordinate position behind the HECM.

The homeowners chose an FHA-insured HECM with a fixed rate of 5.56 percent. The HECM is the nation’s most popular reverse mortgage program, generating about 85 percent of all reverse mortgages in the United States. Other private reverse mortgage “jumbo” funds have virtually evaporated given the present credit crisis. The Federal Housing Administration, a component of the U.S. Department of Housing and Urban Development, also has become more of a primary player in the “forward” or conventional mortgage markets.

A reverse mortgage historically has enabled senior homeowners to convert part of the equity in their homes into tax-free income without having to sell the home, give up title or take on a new monthly mortgage payment. Reverse mortgages are available to individuals 62 or older who own their home. Money obtained from the reverse mortgage is tax-free.

An Atlanta-based counseling agency conducted a new study that points to the value of reverse mortgages as a means to pay off the debt and reduce monthly expenses.

The study revealed the average American senior is bringing in $2,500 per month in income largely from Social Security and pensions. The same senior, however, has $3,500 per month in expenses. The expenses are primarily debt (mortgage, car loan, credit cards). The survey also found while assets have remained fairly stable given the dip in the economy, debt continues to rise.

If you are a senior and struggling with the expenses that are allowing you to remain in your home, take the time to research a reverse mortgage. While it is sometimes difficult to persuade existing lien holders to subordinate to a reverse mortgage product, it has been done.