vol. LXXXIV/no. 3
48 Finance
Business Valuation
y
Minority Interest Discounts:
Are They Appropriate in Valuing Noncontrolling
Interests in Real Estate Holding Companies?
By Martin Greene
y
Personal Financial Planning
20 Questions about Reverse Mortgages:
What CPAs Need to Know
By Thomas Tribunella and Heidi Tribunella
y
26
ESSENTIALS
26 Accounting & Auditing
y
Financial Reporting
The Evolution of Sustainability Reporting:
Utilizing the GRI’s Latest Guidelines
and Looking to Integrated Reporting
By Denise M. English and Diane K. Schooley
y
Financial Reporting
Corporate Finance
Foreign Currency Matters: New Guidance for
Derecognition of Cumulative Translation Adjustments
By Josef Rashty
57 Management
y
Financial Reporting
Improving Stakeholder Value through Sustainability
and Integrated Reporting
By Linda Hughen, Ayalew Lulseged,
and David R. Upton
y
Corporate Finance
Reporting and Disclosures Using
Non-GAAP Financial Measures
By Josef Rashty and John O’Shaughnessy
Is Integrated Reporting in the Future? Considering the
Costs, Benefits, and Role of CPAs
By Harold P. Roth
40 Taxation
68 Responsibilities & Leadership
New York Benefit Corporations:
Bringing Social Responsibility to Business
By Douglas E. Singer and James Day
An Overview of Sustainability Reporting Practices:
Results of Related Research
and Recommendations for the Future
By Silvia Romero, Beixin (Betsy) Lin, Agatha E. Jeffers,
and Laurence A. DeGaetano
y
Not-for-Profit Organizations
y
Corporate Taxation
Structuring a Bona Fide Sale of Excess or
Slow-Moving Inventory for Tax Purposes:
Lessons from Relevant Court Cases
By Mark Wills, Bruce M. Bird, and Michael Sinkey
y
Research
72 Technology
y
What to Bookmark
Website of the Month:
Sustainability Reporting Resources
By Susan B. Anders
74 Classified Ads
79 Economic & Market Data
80 Editorial
A Growing Demand for Assurance
in Sustainability Reporting
F I N A N C E
personal financial planning
20 Questions about Reverse Mortgages
What CPAs Need to Know
By Thomas Tribunella and
Heidi Tribunella
he reverse mortgage is becoming a
popular financial planning tool, especially for retired individuals with limited savings. This article answers common
questions about reverse-mortgage transactions
that CPAs might encounter when helping
homeowners make important financial planning decisions. Furthermore, it considers the
new rules for reverse mortgages, which take
effect in 2013 and 2014.
equity conversion mortgage (HECM), and it
is the only product available through a lender
approved by the Federal Housing
Administration (FHA). The mortgage
insurance premium (MIP) protects the government, lender, and homeowner; however,
homeowners pay the insurance policy premiums. If the lender goes into bankruptcy,
homeowners still receive their annuity from
the insurance policy. HECMs, which represent 90% of the market, are the least
expensive reverse mortgages. There is one
caveat: an HECM must be a first mortgage.
What Is a Reverse Mortgage?
What Are the Eligibility Criteria?
T
A reverse mortgage is a loan where the
homeowner (borrower) uses the home’s
equity as collateral. The loan usually does
not have to be repaid until the last surviving homeowner moves out of the property or passes away. In other words, a reverse
mortgage is similar to a home-equity
loan. (The Exhibit illustrates a timeline of
the reverse mortgage lifecycle.)
How Popular Are Reverse Mortgages?
The federal government insures approximately 70,000 reverse mortgages each
year. Originations peaked in 2009 with
115,000 transactions. In total, 740,000
reverse mortgages have been written,
with approximately 580,000 still outstanding. But to put this in context, only
2%–3% of eligible homeowners have a
reverse mortgage. Given the low U.S. savings rate and a stagnant economy, which
have resulted in a lack of retirement savings for many, this market has the potential to grow. As a result, homeowners without other options will increasingly ask
CPAs for help navigating the risks and benefits of these financial products.
What Is the Government’s Role?
The only reverse mortgage insured by the
U.S. federal government is called a home
MARCH 2014 / THE CPA JOURNAL
A homeowner must meet the following
criteria to receive a reverse mortgage:
n The homeowner must be at least 62
years old.
n The home must be the homeowners’ primary residence; they cannot vacate the
property for more than 12 months.
n The home must meet minimum FHA
property standards.
n Any mortgages or liens on the home
must be paid with the reverse mortgage
proceeds so that the home is owned free
and clear.
n The homeowner must receive reverse
mortgage counseling from an independent
third-party advisor.
n The homeowner must not be excluded
from participation in FHA programs, and
cannot have delinquencies on any federal
debt nor any suspensions or debarments.
n Starting in 2014, there will also be a
credit check and income verification of the
borrower (homeowner).
Reverse-mortgage properties are also
subject to eligibility criteria and FHA
approval. Generally, the property types eligible for a reverse mortgage are single-family homes, two- to four-unit properties (if
owner occupied), condominiums, townhomes, and some types of manufactured
homes.
What Costs Are Associated with an
HECM?
Costs associated with a reverse mortgage
include third-party fees, such as appraisal,
inspection, survey, and lender’s title policy fees. These costs can be significant;
the larger the loan, the easier they are to
justify. FHA upfront MIPs could equal
2.5% of the property’s appraised value if
the homeowner borrows more than 60%
of the property’s value. If the borrowing is
60% or less of the property value, the
upfront fee is 0.5%. The FHA annual
MIP is 1.25% of the annual loan balance.
In addition, servicing fees are charged for
managing the loan; these range from $30
to $35 per month. There are also loan origination fees, points, and interest expense.
Which Costs Are Charged at Closing or
Added to the Settlement?
With a reverse mortgage, homeowners
have practically no out-of-pocket expenses.
Transaction fees, such as appraisal, inspection, title policy, as well as the FHA
upfront MIP, are deducted from the proceeds
as closing costs at the inception of the reverse
mortgage. Periodic fees, such as the FHA
annual MIP and servicing fees, are accumulated and added to the debt and interest
at the end of the reverse mortgage, when the
borrower or estate must settle the liability.
How Much Can an Individual Borrow?
Government-imposed lending limits
determined by the FHA put a $625,500
ceiling on reverse mortgages. The amount
that the homeowner can borrow generally
depends upon a formula that considers
the following four factors:
n The homeowners’ age (older is better)
n Current interest rates (lower is better)
n The appraised value of the home
(higher is better)
n The homeowners’ equity in the property (higher is better).
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What Are the Interest Rate Options?
Which Types of Distributions
Are Available?
There are several ways that a borrower
can receive distributions from a reverse
mortgage. First, a borrower can receive a
lump-sum loan, with a single sum of cash
received at the reverse mortgage closing.
Second, there is a line-of-credit loan, with
withdrawals available at any time until the
line of credit is completely exhausted. Under
the new rules in 2014, lump-sum distributions and credit lines will be discouraged
and limited. From a long-term perspective,
tenure loans offer equal monthly payments, as long as the homeowner lives in
the home. Term loans are also available,
with equal monthly payments for a fixed
number of years. Under the new rules in
2014, term and tenure loans will be encouraged, so that the reverse mortgage can be
used by homeowners as a long-term financial planning tool.
What Are the Alternatives?
Alternatives to reverse mortgages
include home-equity loans or second mortgages. Generally home equity loans/home
equity lines of credit (HELOC) or second
mortgages have restrictive requirements for
a homeowner’s income and credit score.
In addition, with traditional loans, the
homeowner must make monthly payments
to repay the loans. A reverse mortgage usually does not have strict requirements for
creditworthiness, and rather than making
monthly payments, the homeowner
receives cash from the reverse mortgage.
The homeowner could also consider a saleleaseback of the home to achieve some of
the same goals as a reverse mortgage, such
as remaining in the house. If the owners
are willing to move, then selling and downsizing is another option.
There are two interest rate options on
a reverse mortgage: a fixed-rate option
or an adjustable-rate mortgage (ARM)
option. The fixed-rate programs are
specific to each lender and are not
indexed to a published interest rate. To
determine the currently available fixedrate options, a prospective reverse
mortgage lender is required to calculate
a good-faith estimate.
ARMs have interest rates that increase
or decrease as a market interest rate index
changes. The indexes employed today are
the one-year U.S. Constant Maturity
Treasury (CMT) rate or the London InterBank Offered Rate (Libor). Libor is a popular alternative to the CMT for some financial institutions, due to its international
recognition as an index rate.
Starting in 2013, the HECM fixed-rate
option is only available to borrowers who
take an upfront lump-sum loan. The longterm income and line-of-credit loans that
are currently insured by the U.S. government are all adjustable-rate loans.
How Are Adjustable Interest Rates
Calculated?
Interest rates are adjusted periodically
to bring the reverse mortgage rate in line
with market rates. The total interest rate
is calculated by adding an interest rate
index, plus a margin determined by the
lender (interest rate = index + margin).
For example, an HECM CMT 300
ARM refers to an adjustable-rate reverse
mortgage product that employs the CMT
index, plus a margin of 3.00%. If the
CMT index is 1.25%, then the total
interest rate is 4.25% (1.25% + 3.00%)
until the index changes. ARMs are usually reset every year, but different lenders
have different policies (e.g., introductory
rates that are reset at a later date, capped
rates, capped adjustments, and various
reset time periods).
Can the Mortgagee Lose the
Real Estate?
Yes, a homeowner can lose the real
estate behind a reverse mortgage. According
to the FHA, default rates on reverse mortgages due to taxes and insurance range
from 6% to 14%. Fixed-rate, lump-sum
borrowers default at higher rates (10% to
14%), than ARM annuity borrowers (6% to
10%). Clearly, the lump-sum upfront transaction carries more risk than the long-term
annuity. As well as living in the home, homeowners must pay the following four expenses or lose the property:
n Real estate taxes
n Homeowners’ and hazard insurance,
such as flood insurance
n Property maintenance
n Homeowners’ association (HOA) fees.
What Are the Benefits?
There are some substantial advantages
of a reverse mortgage when used as a longterm financial planning tool. For example,
homeowners can convert home equity into
cash while remaining in the house,
assuming that they can cover the taxes,
insurance, and maintenance costs. In
addition, homeowners can increase monthly income through an annuity and can possibly increase cash reserves in a retirement
account. Finally, a reverse mortgage
income and credit check is less rigorous
than for a home-equity loan.
What Are the Risks?
A reverse mortgage is not a transaction without risk. Many times, the home-
EXHIBIT
Reverse Mortgage Lifecycle Timeline
Reverse
Mortgage
Closing
52
Owner
Receives
Loan on Equity
Owner Stays
in Home and
Pays Expenses
Owner
Leaves Home
Owner
or Estate
Repays Debt
MARCH 2014 / THE CPA JOURNAL
owner/borrower is in need of cash and
going into debt at an advanced age;
therefore, the estate will probably sell the
home in order to satisfy the liability. As
a result, the heirs will probably not inherit the home. In addition, inflation presents a risk. If prices rise rapidly, the
annuity might not cover the borrower’s
living expenses (e.g., property taxes,
insurance, and maintenance costs); this
could result in the homeowner losing the
property.
n The homeowner wants to stay in the
home.
What Are the Related Income Tax
Issues?
The payments that the homeowner
receives during the course of the mortgage
are not considered income because they
represent proceeds from borrowing. Interest
is deductible when paid. In the case of
reverse mortgages, this is when the mortgage is complete and the repayment of
the loan is made to the lender, generally
Who Is Liable if a Sale by the Estate
Cannot Cover the Debt?
When the last surviving homeowner
passes away, the estate has six months to
repay the balance of the reverse mortgage. This includes debt, interest, servicing fees, and annual insurance. The estate
can also sell the home to pay off the
reverse mortgage balance. Any remaining
equity is inherited by the estate. The
estate is not liable if the home sells for less
than the balance owed on the reverse mortgage—the MIP required by the FHA covers the remaining liability.
Can a Surviving Spouse Stay in the
Home?
Yes—if the owner passes away and the
surviving spouse is listed as an owner on
the reverse mortgage. But any dependents
must leave the home at the end of the
reverse mortgage period if the borrower
cannot pay off the loan balance.
Who Is a Good Candidate for a Reverse
Mortgage?
If the following attributes are present, a
homeowner might want to consider a
reverse mortgage:
n The homeowner is in need of an annuity during retirement.
n The homeowner is older and has a significant amount of equity in the home.
n The homeowner has no dependents or
the dependents do not need the house.
n The homeowner is in danger of losing
the home due to expenses such as insurance, taxes, and maintenance costs.
n The homeowner is a healthy person who
can live in the house for a long time.
n Inflation is not expected.
n Interest rates are low.
n The homeowner wants to maintain a
higher balance in a retirement account.
MARCH 2014 / THE CPA JOURNAL
The payments that the
homeowner receives
during the course of the
mortgage are not
considered income
because they represent
proceeds from borrowing.
when the homeowner no longer occupies
the home. But homeowners can still deduct
their property taxes if they are not alternative minimum tax (AMT) taxpayers.
If the loan proceeds are used to buy,
build, or substantially improve the home,
the deductibility of interest on reverse mortgages is subject to the same limitations as
interest paid on regular mortgages. Interest
is deductible for loans related to acquisition indebtedness up to $1 million for married filing joint taxpayers and $500,000 for
a single taxpayer or married filing separately taxpayers.
If the loan proceeds are not used to buy,
build, or substantially improve the home,
the deductibility of interest on reverse mortgages is subject to the same limitations as
interest paid on home-equity loans. Homeequity interest is limited to the interest on
the portion of the loan that does not exceed
$100,000 for taxpayers who are married
filing jointly or $50,000 for single taxpayers. For taxpayers subject to the
AMT, however, reverse mortgage interest
is not deductible and would result in a positive adjustment to AMT income. Interest
deductibility is a complex topic; a complete explanation of this issue can be found
in IRS Publication 936, “Home Mortgage
Interest Deduction” (http://www.irs.gov/
pub/irs-pdf/p936.pdf).
Capital gains rules for primary residences also apply to reverse mortgage
property. After the house is sold to pay the
reverse mortgage, the capital gain is subject to the $250,000 capital gain exclusion for single filers ($500,000 for married
taxpayers filing jointly).
What Are the Related Estate Tax
Issues?
Once the homeowners are deceased, the
home—along with the reverse mortgage
and related interest and fees—will be transferred to the estate. When calculating the
taxable estate, the amount used to pay the
reverse mortgage will be treated as a
deduction on the estate tax return. The
amount paid for interest on the mortgage
would be subject to the limitations discussed above. If the heirs would like to
keep the house, a reverse mortgage can
be problematic, because the estate would
have to contain enough other assets to
settle the reverse mortgage upon death of
the homeowner.
What Are Sources of Additional
Information?
The following websites provide additional material on reverse mortgages:
n National Reverse Mortgage Lenders
Association (http://www.reversemortgage.org)
n U.S. Department of Housing and Urban
Development (http://www.hud.gov)
n American Association of Retired
Persons (http://www.aarp.org)
n National Association of Realtors
(http://www.realtor.org)
n AICPA (http://www.aicpa.org)
q
Thomas Tribunella, PhD, CPA, is a professor of accounting in the school of business at the State University of New York
at Oswego. Heidi Tribunella, CPA, is a
clinical associate professor of accounting
in the Simon School of Business
Administration at the University of
Rochester, Rochester, N.Y.
53