Mortgages are the number one way seniors are able to purchase their homes. If a senior has a mortgage, or is considering refinancing, or getting a mortgage, what do they need to know? What are the different types of mortgages? What are different payment options?
How Seniors Think About Mortgages
Seniors care about their mortgage for a variety of reasons. The comments Carmen and I heard most frequently about mortgages were variations of “I paid off my mortgage,” “My home payment is low,” and “I can always use the equity in my home if I need money.” Although these comments are a bit contradictory, the sentiment is the same. My home is my security. For some it means living in their home without a mortgage. Others see it as a way to tap their home’s equity for income. For many, it will mean both.
Carmen and I used to work at a big national bank in the consumer lending department. I developed home loans for consumers. That meant working with our treasury department to figure out our funding costs; negotiating with our underwriting department to assess underwriting criteria and risks; understanding our actual costs and profitability goals so I could recommend pricing; understanding consumer lending law; and conducting studies with consumers to figure out what they liked and preferred in terms of loan features and functionality.
When Seniors Believe Their Mortgage Will Be Paid Off
Most seniors perceive their mortgage as their most important expense.
Most seniors believe that they will pay off their mortgage. But is that their best move? Why are so many seniors now considering a reverse mortgage?
Before we even consider what you should do with your mortgage, you should know something about mortgages.
So what mortgages are best for seniors? Are any mortgages good for the elderly? Are mortgages better for seniors in California, New York, and Florida? Worse for seniors in Pennsylvania, Tennessee, and Texas? What about mortgages for seniors in Washington, Oregon, Michigan, Ohio, Illinois, Colorado, Arizona, Nevada, Utah, Georgia, and North Carolina?
The word mortgage is from an old French meaning “dead pledge” or “death vow.” This references the loan that requires repayment for termination (i.e., death pledge). Not the borrower. But the borrower’s needs are key to understanding the utility of the loan. Every borrower is different, but elderly borrowers address a similar set of issues. Seniors should consider these before paying off a loan, refinancing and or getting a new loan for a new home. These issues are reviewed below.
How Mortgages Can Help Stretch A Senior’s Resources
Keep in mind that an extraordinarily wealthy borrower simply pays others to help them address their needs. They don’t need the equity (untapped money) in their home. For the rest of us, the older we get, the less we’re able to do for ourselves. We need to stretch resources and rely on the help of others. Often the equity in our home, or the value we can create from our home, is our primary resource.
Key Issues When Using Home Equity As A Resource
Many seniors leap at the chance to use their homes as an economic resource. They want to tap the “equity” in their home or they want to rent a room in their home for extra income.
Financial concerns are all about your finances. What you have, and what you’ll need. If you don’t fully understand these issues, messing up a mortgage can have catastrophic consequences. For example, losing your home.
Financial concerns center around how the borrower wants to allocate limited resources over their remaining life. Equity in a senior’s home is often our greatest asset. This equity can be used to help provide income to a senior in their retirement. How it’s accessed becomes the question.
Here are some key financial issues seniors need to think about.
Accessing equity via a mortgage comes with repayment obligations. Payments can be a small or large part of a senior’s monthly income. The larger it is or becomes, the more sensitive the borrower is to how payments affect their fixed monthly income.
The greater the payment, the less we have for other expenses. Variable-rate loans often start with lower rates than fixed-rate loans. But over time, the rate usually goes up. Fixed-rate amortizing mortgages have very predictable payments but have rates higher than variable rate loans.
Qualifying For A Mortgage
Qualifying for a loan can be a challenge for seniors. Seniors usually have lower monthly income than people in the prime of their careers. Lenders often underwrite (qualify) a borrower based on their ability to meet the loans required monthly payment. The lower the payment, the easier t is to qualify. Variable-rate loans with their lower initial payments make it easier for seniors to qualify.
Need For Future Equity
Every senior needs to consider their future needs and resources. See our Section on Finances here for details. However, the basic question can be said here. Do I want to use equity for my current neds, or save it for my future needs?
It’s important to know the total costs associated with maintaining a home. Some seniors have been in their homes for many years, but have neglected maintenance. Combined with the age of the home and appliances the costs of that maintenance are much higher than the costs had the homeowner been performing regular maintenance. Annual maintenance costs can easily be 1% of a home’s value, and if the home is old, and maintenance has been neglected, much higher.
Most seniors don’t want to take out a loan to discover that all the proceeds need to go to home maintenance. See our Section on Home Maintenance here. The total costs associated with owning a home help a senior assess how much money they’ll need to afford the home or borrow against their current home to stay.
If the homeowner is incapacitated or is likely to become so, the costs needed to keep this owner in the home needs to be considered. This can easily be $40,000 – $80,000 a year. See our Section on Health here.
Competency concerns center on the “competency” of the senior. Simply put, if the senior’s competency is declining, their ability to manage their home also decreases. Competency concerns fall into the following issues.
A homeowner’s health and competency is really important. If an elder homeowner is neither healthy or competent, someone else has to do all the things to manage and maintain the house. In addition, other people are needed to care for the homeowner. In short, the homeowner is transforming their home into an assisted living facility, or in extreme cases of poor health, a nursing home.
Family issues concern family members and their relationship to the senior’s home. Does a spouse depend on the home? Are they significantly younger? Are their children or grandchildren that are dependent on the home. Do they provide income for this dependency or the opposite? Family issues include:
As seniors, we often find ourselves in a position where we care for an unhealthy spouse. Both spouses are comfortable at home. Alternative simply don’t make sense. At least for now.
Some seniors have stepped in for their children and are taking care of grandchildren. Other seniors are helping a family member address addiction or mental health issues. In both cases the family home may be meeting the needs of the seniors and these others. Without the family home, others may suffer the consequences.
Toward the end of their life, seniors often find themselves in need of others to help manage their day-to-day life. From cleaning the house to managing medication. Sometimes a home can help leverage that help. For example, a senior can trade free room and board to a family member (e.g., niece, child, grandchild, etc.) for help around the home. Alternatively, a senior might rent out a room or two and use the extra money to hire help with these things.
Psychological issues focus on how the senior perceives their homes. Homes have huge psychological connection with their homes. We discuss these here. The basics are:
Senior’s number one concern is staying in their home. There are many reasons for this belief. Regardless of the reason, accommodating this need has extreme repercussions. Does the senior have enough money? If not, do family members make up the shortfall? If so, which ones and in what amounts. Can a mortgage help address the senior’s needs?
Mortgages are essentially IOUs guaranteed by your home. A promise to pay money in the future for money received today. If you don’t pay, the lender can take your home for payment. Mortgages have lots of different names like home loan, real estate loan, equity loan, and equity line. But they all share the following characteristics:
Before we start, you need to know about APRs.
Annual Percentage Rate (APR)
The APR represents a percentage of the actual annual cost of borrowing over the total life of the loan. This includes any fees or additional costs like points, closing costs, legal fees and origination fees. There are different applications of the APR for closed (amortizing) loans and open-ended loans. You don’t need to know how to calculate these, but you should know that when comparing similar types of loans, the APR allows you to compare relative costs of the loan. Lenders are obligated by law to present the APR and mistakes on their part can incur massive fines. So the APR is almost always a great way to compare loans from different lenders.
Sometimes lenders don’t include and exclude the same fees. So it’s worth asking to make sure you’re comparing equally.
Fees Associated With Mortgages
Common Mortgage / Loan Types & Terms
When we talk “types” in the lending industry, it mostly means how the repayment amount is calculated. This calculation is based on the outstanding principal and the charged interest rate. Rates can be fixed or variable. This leads to the most common types of amortizing loans: fixed and variable.
Fixed-Rate Amortizing Mortgages
This is the vanilla form of a home loan. Seniors should never underestimate vanilla. Simplicity is very helpful, especially as we age. Knowing what my payment will be for the length of the loan creates certainty. Planning with a certain variable is always easier than planning with uncertain variables.
For a fixed rate fully amortizing loan, the lender offers you an amount, and you agree to pay it off over a fixed period, usually 10, 15, or 30 years. Payments are fixed for the term of the loan. Each payment is made up of principal and interest. Early in your loan, most of your monthly payment is for interest (the principal balance is high), but over time this gets reversed.
Adjustable Rate Mortgages (ARMs)
ARMs are complicated. They involve adjustments based on indexes, negative amortization, annual payment caps, periodic interest rate caps, life of loan caps, adjustment period re-amortization calculations, and other characteristics.
Once upon a time they came in unlimited varieties and included interest-only options, variable amortization election periods and other exotic features. But today, they are relatively standard because the government entities that buy home loans will not purchase exotic ARMs.
Most ARMs have a fixed-rate period, often called a teaser rate. However, a straight-up ARM adjusts monthly, quarterly or annually. They are highly volatile because the rate and payment are changing frequently. The rates are lower than alternatives but because the payment jumps around, there is little value to the borrower other than a low rate (compared to alternative loans). The adjusting mortgage loans are usually only recommended to the very wealthy and military personnel. The wealthy can use the money not spent on the mortgage for other investments. Military personnel that move frequently may also like the low payment, especially given the reality of moving in a year or two. These loans are almost never appropriate for seniors. We won’t cover them here.
Hybrid Adjustable Rate Mortgages (ARMs)
This post will only address the most common forms of ARMs. These are hybrid ARMs that allow a borrower to lock in a rate for 3, 5, 7 or 10 years. The “lock-in” rate is often referred to as the “teaser rate.” After this initial lock-in period, these loans adjust, usually on an annual basis. Because these loans adjust, the borrower shares in the interest rate risk. The lender recognizes this shared risk by lowering the initial rate for a lock-in period. These ARMs are referenced as 3/1, 5/1 and 10/1 ARM. The first number reflects the initial lock-in period, the second, the ensuing adjustment frequency. A 3/1 ARM is a loan that has a fixed rate for three tears and annually after that.
Rates are tied to an index plus the bank’s margin. Adjustments can occur anytime, but most ARM adjustments are made after an initial lock of three to five years. After that initial period, the rate changes based on the type of ARM you have. Let’s say the ARM rate is 5%, but will change after 3 years. For the first three years, your rate is locked at 5% and your payment reflects this rate.
The current rate is based on an index plus a spread. The index might be the prime lending rate, and the spread might be 2.5%. So when the adjustment period occurs, the new rate would be the current prime rate plus 2.5%. ARMs are usually priced lower at first, because they allow the bank to adjust when rates change.
ARMs come with lots of terms and conditions. Here are a few:
Caps – Interest Rate
An interest rate cap is a limit on how much your interest rate can change when it’s time for an adjustment. If your ARM adjusts every year, the interest rate cap limits this adjustment. In most ARMs the first adjustment period’s rate cap is higher than the ensuing adjustment periods. It can be between 4% and 7%. This protects the bank if it locked in a rate and rates have risen dramatically over time. Think of it as a catch-up adjustment. After the first adjustment, caps come in and usually are between 1.5% and 3%. There are also lifetime interest rate caps. These limit how much the interest rate can rise over the life of the loan.
Caps – Payments
A payment cap is a limit on how much your payment can increase from one adjustment period to the next, and over the life of the loan. These caps are usually applied as a percentage of the loan. Because a payment cap can prevent payments from covering the interest owed per a normal amortization schedule for that period, the loan can have what’s called negative amortization.
Negative amortization is when the monthly payments do not cover all the interest owed. The unpaid interest not paid in the monthly payment is added to the loan balance. If enough of of these types of payments are made, you may owe more at the end of your loan than you did at the beginning. This is only likely to happen in very volatile interest rate environments where rates go up dramatically between adjustment periods or when interest rate caps are very narrow.
Loan Types – The Common Ones
Below are the most common loan types. The ones the government entities that buy loans are willing to purchase. If you’re looking for a more exotic loan type, call a wealth management group. They often portfolio their own loans or sell them to private investors.
Home Equity Loans
Home equity loans are usually second position loans where a borrower needs a second loan in addition to their first loan. Most banks will lend up to 80% of the homes appraised value, so if your homes worth 200,000, and you have a $100,000 first mortgage, you may qualify for an additional $80,000 home equity loan. Home equity loans come in two main varieties: fixed-rate loans and lines of credit.
The lender gives the borrower a fixed amount of money (the loan), and the borrower pays it back over time on a fixed schedule. The payment is amortized, a combination of principal and interest, and stays the same over time.
Home Equity Lines of Credit (HELOC)
The lender gives the borrower access to a certain amount of money (the credit line). The borrower then accesses this money as needed. They also pay this money back when they want. When money is accessed, the bank applies an interest rate to the funds accessed. When the borrower pays that back, the interest rate on that portion ends. These loans must be fully paid at the end of the loan.
Best Mortgage Options For Seniors
It’s impossible for Carmen and I to tell you what the best mortgage options is for you without knowing all the details about your situation. However we can share some tips that Super Agers told us about.
Selling To A Trusted Family Member
We met several Super Agers that sold their home to a trusted family member. This allowed them to generate funds to use in retirement. Their family member then agreed to lease their home back to them at a monthly rate for a period of time, as long as certain conditions were met. These conditions included things like time and the ability of the Super Ager to safely live in the home.
These types of transactions have lots of tax implications for both parties. Generally, market rents must be charged, or someone is getting a gift or income. If the gap between market rent and the actually paid rent is considered income, that income needs to be declared.
These transactions may have certain benefits for the Senior if the senior wants to pay down their resources to qualify for Medicaid. As the senior uses up the proceeds of the sale, they are essentially impoverishing themselves. At some point they will qualify for Medicaid. If an impoverished senior has a qualifying medical condition requiring nursing care, Medicaid will pay for this care.
Low-Interest Rate Mortgages
Some Super Agers had a good idea of the years they had left and refinanced into low-interest rate adjustable-rate loan. By paying a very low rate for a period of five to ten years the senior believed they could enjoy using the money from refinancing and not have to worry about the house when the rates went up because they’d be dead.
No one really knows how long they have or whether science will come up with a new way to extend your life. However, some seniors truly believed they only have a few years left and want to enjoy those years. They were willing to accept any consequences that might arise from living longer.
Getting Help From A Financial Adviser To Select & Manage A Loan
We noticed that Super Agers with homes of equity over $300,000 used professional money managers to help optimize loan options. These professionals had financial optimization tools that they used in conjunction with a senior’s housing, financial, and life expectancy objectives.
Good financial planners can use the equity in your home to generate more income than leaving the equity untapped. They can help select the best loan and use access funds to generate income.
If the senior has challenges managing their own finances, the advisor can also step in and help the senior pay and manage bills, or coordinate this with who the senior appoints as their representative.
Other Resources On Mortgages
See our Section Using Your Home As A Piggy Bank here.
Great loan calculator Here: