There’s no question that one of the main reasons for the rapid rate of growth in the reverse mortgage industry has been home price appreciation in “hot” areas of the country. Over the last several years, the top markets for HECM reverse mortgages have consistently been the California and Florida markets.

These markets also dominate the index of reverse mortgage friendliness, a simple measure that compares the interest rate on a reverse mortgage with average home appreciation rates. It’s a straightforward notion: when home price appreciation rates match or exceed borrowing costs, there is added incentive to tap home equity via a reverse mortgage. The homeowner can use the funds for living expenses and still grow the value of the estate. Refinancing a reverse mortgage is also a more palatable option when home values are soaring.

But what about when home values stagnate or decline, as they are now in many parts of the country? What are some things potential reverse mortgage borrowers should consider? We’ve listed below some of our thoughts:

• A reverse mortgage can be a tool to lock-in value. As with any type of home loan, an appraisal of the home’s value is a cornerstone in determining how much can be borrowed. But unlike a traditional forward mortgage (where owners can end up obliged to repay more than the home is worth - i.e. going “underwater”), this cannot happen with a reverse mortgage. Reverse mortgages are non-recourse loans and you can never owe more than the value of the home at the time the loan terminates.

  If you’re in an area where housing prices are in a long-term slide, a reverse mortgage could be a viable way to lock-in and cash out value at today’s levels and still have a home to live in without the worry of going underwater.

• Michigan as an example. As noted, the nation’s hot housing markets have also been the hotbed for reverse mortgage activity. Surprisingly, though, reverse mortgage activity has been strong in some areas with little home value growth. Michigan, which according to the Office of Federal Housing Enterprise Oversight (OFHEO) ranked 50th in housing value growth for the 5-year period ended March 31, 2007 ranked 6th highest among state in terms of HECM reverse mortgage activity for the period January 1, 2003 through April 30, 2007.
• Total borrowing costs (TALC rate) in some cases be lower when home prices decline. TALC is the “total annual loan cost” for a HECM reverse mortgage. Though imperfect, TALC is the most complete measure of reverse mortgage loan costs available as it takes into account all factors including fees, interest costs, home value changes and the time-value of money. (Conceptually, TALC can be thought of as the “APR” for reverse mortgages.)

  It is surprising but true that for two otherwise identical HECM loans, the TALC rate can be lower over time for the home having the lower appreciation rate. This results because the growing reverse mortgage loan balance (amount owed) can grow at a faster rate than the home value. At some point, the amount owed will catch-up to and then be limited by the home’s value.

  It is entirely possible for a HECM borrower who remains in a slowly appreciating home for many years to have a very low TALC rate and to have borrowed far more than the amount repaid at loan termination.

• Declining values can be a maintenance disincentive. Reverse mortgage loan documents require that borrowers/homeowners maintain their property in good condition. After all, the home is the loan security and, also, the ultimate source for repaying the loan. Yet when property values fall, it can be difficult for homeowners to invest scarce cash into a home with depreciating value.

  Yet borrowers need to understand that failure to properly maintain the home can constitute a default on the loan and result in foreclosure.

• Refinancing is an option. What if home values turnaround a rise sharply in your area? Refinancing an existing reverse mortgage is doable, although the borrower incurs many closing costs again. (HECM loans do provide some relief by charging the 2% FHA mortgage insurance premium (MIP) only on the incremental difference in maximum loan amounts between the first borrowing and the refinancing.

Clearly the best scenario for homeowners/borrowers is to live in a dwelling that is rapidly appreciating in value. But, if you’re not so fortunate to be in this situation, realize that a reverse mortgage can be a sound strategy even in areas with declining home values.

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