Much is being made of a report just released by National Consumer Law Center (NCLC), entitle “Subprime Revisited: How the Rise of the Reverse Mortgage Lending Industry Puts Older Homeowners at Risk.” Analysts and industry-watchers have homed in specifically on the explicit comparison between reverse mortgages and subprime mortgages.
While the mechanics of the two mortgage products are quite different, there is a tremendous overlap in their essence, and hence the way in which they are being promoted. For example, both subprime mortgages and reverse mortgages are designed to appeal to a class of potential borrowers whose respective financial situations are especially precarious. For many of these borrowers, they are in desperate need of financing, and simply have nowhere else to turn.
Perhaps the most poignant similarity is the way in which the two mortgage products are being marketed. TV commercials are pitching reverse mortgages as some kind of government entitlement program, the proceeds of which can be used to pay for anything, from a sailboat to medical bills. Argues the NCLC, in its report:
Many of the same players that fueled the subprime mortgage boom — ultimately with disastrous consequences—have turned their attention to the reverse market. Lenders, including some of the nation’s largest banks, view that market as a source of profits that have dried up elsewhere. Mortgage brokers see it as a new source of rich fees. Predators who once reaped profits from exotic loans have now focused on wresting more wealth from vulnerable seniors. And securitization, which allowed subprime loan originators to disassociate themselves from the downside risks of abusive lending, is becoming commonplace in the reverse mortgage industry.
In addition, the same perverse incentives (i.e. lack of consequences) that characterized subprime origination is also present in the origination of reverse mortgages. The main difference is that the “victims” in the subprime crisis were the investors foolish enough to underwrite the mortgages. (Of course, some borrowers suffered as well, but many were no worse off than before taking out a subprime mortgage).
Reverse mortgages, in contrast, can potentially victimize the borrower directly, and American taxpayers indirectly. While defenders of reverse mortgages rightfully tout their benefits, the truth is that the product doesn’t make financial sense for the average borrower, since it trades cash for equity at an unfair exchange rate. Certainly, many retirees are grateful to receive seemingly “free” cash while still retaining the right to residency, but many others are shocked when 15 years later, most of the equity in their home has already been depleted. At which point, they basically become hostages (in the words of one columnist) in their home, since moving out would leave them with little proceeds and with no place to live.
The government, meanwhile, bears ultimate responsibility, due to the insurance that it underwrites on 90% of reverse mortgages. The FHA – the agency which manages this process – has seen its reserves fall to the lowest level in 75 years, and analysts are now talking about a bailout in the same manner as Fannie Mae and Freddie Mac, which we all know lost billions guaranteeing subprime and other junk mortgages.
In short, while the analogy isn’t perfect, it’s still apt. Summarized U.S. Senator Claire McCaskill, who is leading the calls for reform, has pointed that 10,000 new borrowers become eligible for reverse mortgages every day (by virtue of reaching the required age of 62), and that as much as $4 Trillion in untapped equity remains “trapped” in their homes. “We’ve seen this movie before, and it didn’t have a pretty ending. Abuses in the subprime lending market almost brought down our economy. Now we’re seeing similar abuses with reverse mortgage lending. Something needs to be done before more life savings are depleted and more tax dollars are drained.”
Those in the process of applying for conventional mortgages couldn’t have picked a better time; housing prices are low, and interest rates are lower. The same, however, cannot be said for reverse mortgage borrowers, who benefit from low interest rates, but not from low housing prices.
The main factor in determining the maximum reverse mortgage for a given borrower is the quality of his collateral (i.e. the house being mortgaged). Further, the value of the house is determined via an appraisal, which is non-negotiable, and afterward, a percentage is applied, based on the borrower’s age and prevailing interest rates, and the size of the mortgage is computed.
In other words, the appraisal is arguably the most important step in the reverse mortgage application process. Significant changes to the way that appraisals are conducted, however, have resulted in lower appraisals. In the wake of the housing crisis, legislation was enacted, seeking to limit pressure on appraisers to confirm overstated home values. The new system hands the reins to the lenders, which are in charge of appointing appraisers and signing off on their work. Moreover, lenders have a vested interest in keeping appraisals low (especially after the housing bubble burst), and anecdotal reports suggest that this has become the norm.
Tough luck for potential reverse mortgagers, most of whom seek to borrow the maximum allowable amounts. Their situations arn’t helped by the housing market, which remains weak, and is projected to remain weak for the foreseeable future. A reasonable option, then, is to simply wait until the housing market improves. After which point, many borrowers will presumably be entitled to larger loans, due both to home-price appreciation and having aged by a few years. The downside is that interest rates could increase, making the loan relatively more costly.
Of course, reverse mortgages are designed to appeal to those whose financial situations are somewhat dire, so many applicants might not have the luxury of being able to wait. For this category of borrowers, you can always refinance (though incurring more fees in the process). In addition, you can still reap the benefit of home-price appreciation- not in the form of a larger loan, but in a greater equity position, the gains from which which will be realized when the home is sold and the mortgage is repaid.
The FHA, which insures most reverse mortgages and is generally regarded as the industry watchdog, has responded to this issue in contradictory ways. On the one hand, its new Reverse Mortgage for Purchase loan (the subject of my last post) is calculated from the appraised value of the home, even if it’s higher than the sale value. On the other hand, it recently moved to curtail loan amounts by 10% on conventional reverse mortgages, due to concerns of depressed housing prices and a consequent increase in defaults. Given the FHA’s increasingly precarious financial position, unfortunately, it seems the latter approach is set to become the norm.
I set out to write today’s post about a clever idea that I had recently conceived: using a reverse mortgage to purchase a home. While reverse mortgages are conventionally used as a last resort by homeowners that want to stay in their respective current homes but lack the means to do so, I figured that such could also be theoretically be used to purchase a new home by retirees that likewise lacked the means to do so.
Alas, a little bit of research revealed that I was not the first to think of such a clever idea. In fact, it turns out borrowers have been utilizing reverse mortgages in this way for over 10 years. Originally, the product of choice was the Fannie Mae Home Keeper for Home Purchase program, which provides modest loans for borrowers that can’t afford an all-cash transaction but want to to avoid the monthly payments associated with a conventional mortgage.
On January 1, 2009, this product became irrelevant, as HUD officially began underwriting Home Equity Conversion Mortgage (HECM) for Purchase loans. Made possible by legislation associated with the economic stimulus, this program exists for the sole purpose of enabling borrowers to fund the purchase of a home using a reverse mortgage. Since I haven’t heard/read otherwise, I’m assuming that the same loan limits apply to this product as apply to vanilla HECMs ($625,500).
There are a couple of special features/limitations, however, that distinguish this from a normal reverse mortgage. First of all, the down-payment for the home must be funded completely with cash. Credit card debt, bridge loans, gifts from relatives (bank accounts are to be scrutinized), and of course the reverse mortgage itself, are all forbidden to be sourced. Second, the size of the reverse mortgage is determined based on the appraised value – not the purchase price – of the home. In this way, borrowers receive a “reward” for purchasing undervalued homes.
Next, there is a provision that prevents borrowers from having to pay a second mortgage insurance premium, if they already have a reverse mortgage outstanding. The rules require the borrower only to pay the difference (if any) between the old and new premiums. Finally, there is an anti-flipping stipulation, which essentially aims to prevent the product from being used for fraudulent or speculative purposes, by auditing mortgages on homes that were sold within 180 days from the previous sale.
On the surface, the HECM for Purchase loan is a great way for retirees to buy a new home at a fraction of the cost, without assuming any new debt. Of course, there’s no such thing as a free lunch, and the program is not without its drawbacks. High upfront costs and comparatively high interest rates limit the prinicipal size and erode one’s equity. In effect, reverse mortgaging a new home is tantamount to renting it. Non-refundable fees/costs are akin to rental payments, and it’s impossible to build equity, since any home-price appreciation will probably be offset by the payment of compound interest. Still, for those that have their eyes set on owning a home – even in their twilight years – the program represents a viable way to do it.
A quiet, but important change in reverse mortgages goes into effect today. In one foul swoop, the Federal Department of Housing and Urban Development (HUD) slashed principal limits on all reverse mortgages by more than 10% in some cases. In other words, the total amount that you can borrow using a reverse mortgage (home equity conversion loan) is now 10% less than it was yesterday.
It’s unclear exactly what motivated the change. Government officials and policymakers have long been mulling changes to the regulatory structure of reverse mortgages, due to claims of abuse and concerns that they aren’t appropriate for certain borrowers. This particular change may also have stemmed from fears that if housing prices decline further, many reverse mortgages could soon go underwater, leaving HUD (and taxpayers, indirectly) on the hook for Billions of Dollars.
Naturally, industry insiders are furious. How dare you deprive seniors of their deserved cash, they argue. Of course, it’s not the sense of mortgage injustice that bothers them so much as the potential affect on business. It turns out that an overwhelming majority of reverse mortgage borrowers have existing liens (i.e. primary mortgages) on their home, and use a large portion of the proceeds from the reverse mortgage to retire these liens. Research also shows that most of these borrowers remain unwilling to divert cash from other sources (i.e. savings accounts), which means the HUD-mandated principal decline could ultimately dissuade them from taking out a reverse mortgage. It doesn’t help that many reverse mortgage borrowers have particular tenuous financial situations, such that after this kind of change, a reverse mortgage simply wouldn’t be viable.
The precise principal limits can be found in this table, recently released by HUD. Based on the age of the borrower and interest rate offered under the reverse mortgage. it computes a percentage of the value of the collateral (one’s home) which can be tapped into. A borrower over the age of 98 with an interest rate under 5.5% can withdraw 81% of the value of their home, while a borrower aged 62 paying an interest rate of 19% would be eligible to withdraw a paltry 5% Hardly worth it in that case.
The calculations are based on certain actuarial assumptions regarding life expectancy and house price appreciation, and represent the maximum borrowing amount as stipulated by HUD. For potential borrowers who just can’t make a reverse mortgage work for them under the current limits, the recommended course of action is to wait for housing prices to rise again, continue to pay down your mortgage and/or simply wait until you’re older. Based on the table, you can see that every additional year you wait, you will be entitled to an additional .7% of the value of your home. For a $250,000 a home, that’s an additional $1,750 just for waiting a year! Not bad.
Let’s face it. Reverse mortgages are inherently complex. At least when they were first introduced, the number of lenders and the range of available products were both relatively small, such that once the decision to borrow using a reverse mortgage was made, there wasn’t much left to decide. Over the last few years, however, the surge in reverse mortgage lending has been accompanied by a commensurate surge in innovation. As a result, the process for obtaining a reverse mortgage is now a whole lot more complicated.
Unlike conventional mortgage rates, which are correlated with credit-worthiness, reverse mortgage rates are correlated with the quality of your home. This is because with a reverse mortgage, there’s very little default risk. There is only a risk that your home will decline in value, to the extent that it will be worth less than the balance of the reverse mortgage.
With a so-called plain vanilla reverse mortgage, the interest rate is fixed for the duration of the loan, just like with a conventional mortgage. The only difference is that the balance on a conventional mortgage (and consequently, the interest) will decline to zero, whereas the balance on a reverse mortgage will continue growing until the mortgage is repaid (i.e. the borrower passes and/or the home is sold).
With a variable rate reverse mortgage, the interest rate can fluctuate from month to month (or year to –year) depending on changes in benchmark interest rates. Unfortunately, variable rate reverse mortgages are not as comparable to variable rate conventional mortgages, which make them difficult to conceptualize. That’s because variable rate conventional mortgages are usually obtained with the intention of refinancing when rates get too high, and enable borrowers to automatically convert the variable rate to a fixed rate after a certain period of time. Reverse mortgages on the other hand, while theoretically can be refinanced, or rarely done so in practice, because of high upfront costs. In addition, while the FHA caps the maximum rate hike to 10%, this doesn’t really provide much in the way of security.
So how do you know which type is right for you? Like their cousins over on the conventional mortgage side, fixed rate reverse mortgages are safer, more transparent, and conducive to financial planning. Since there is no risk that the interest rate will fluctuate, your lender will be able to tell you on Day 1 how much is available to you under the loan. With a variable rate reverse mortgage, you will probably be limited in your ability to withdraw funds, especially if you want to receive the loan in the form of a lump-sum payment. This is because the bank must guard against sudden interest rate hikes, which could lead to an underwater mortgage. On the other hand, for those relying on a reverse mortgage for temporary financial needs, a variable rate mortgage could lead to significant savings in a low interest rate environment. Just make sure you understand that your equity will be eroded faster when rates rise, and that the funds available to you will be smaller than if you had opted for the fixed-rate version.
As with a conventional mortgage, you should shop around for the best rates. There probably won’t be too much disparity between rates quoted by the most reputable lenders, since their costs are standardized and all loans are ultimately underwritten by the government, via the Federal Housing Administration. Still, it doesn’t hurt to compare rates, especially if you have been solicited by a lesser-known lender, which could potentially take advantage of the relative obscurity of reverse mortgages by insisting on a higher interest rate.
My personal attitude towards reverse mortgages is that they should be thought of as a last resort, by those at or near retirement who are desperate to remain in their homes but lack the funds to do so. With that in mind, I’d like to use today’s post to address the emerging trend of using reverse mortgages to fund investments.
Let’s begin by understanding how this strategy works. Basically, one approved for a reverse mortgage can technically use the proceeds for any purpose, from paying off a current mortgage to buying a new car, from making repairs on a home to paying for a nephew’s college education. A new school of thought holds that it is sensible to take the proceeds and invest them. The reasoning is that such is a form of diversification, by taking capital that was otherwise concentrated in real estate (i.e. one’s home) and allocating it among various other assets.
Contrary to what its advocates would have you believe, the strategy is hardly novel. Mortgage borrowers (sometimes with encouragement from financial planners) have long been using home equity lines of credit and unconventional mortgage products, as means for using their home as collateral to gamble in the stock market.
On the one hand, the credit crisis pretty much obliterated any viability in this strategy. On the other hand, the credit crisis simultaneously proved that keeping all of one’s assets in one’s home was also not the most sensible investment. The important distinction, however, is that a home provides utility (i.e. it can be lived in), whereas 100 shares of Microsoft provide no such utility- only the possibility of appreciation.
Over the long-term, equities have typically outperformed real estate. Based on this logic, some would argue that it’s reasonable to invest more money in the stock market than in your home. All else being equal, this strategy could be defended. Using a reverse mortgage to fund such investments is slightly less defensible.
If your reverse mortgage APR (i.e. the real annual cost of the loan, including all fees, insurance premiums, etc.) is 6% and you are confident you can earn a 9% return by investing in an S&P 500 Index Fund, you just nabbed a 3% return, without doing any work. After accounting for taxes however, your return is probably closer to 2%, which is approximately equal to the long-term rate of inflation. In other words, you gambled with the equity in your home to achieve a real return of 0%. Of course, there are plenty of people who won’t be deterred by this argument, but these are probably the same people that consider BlackJack a type of investment.
What about wealthy people who have money set aside for retirement, and can afford to gamble their home equity in the stock market? For such people, it seems unlikely that they would need a reverse mortgage, since those who can afford to retire comfortably probably have plenty of ziquid assets. It would be equally unsuitable for upper middle class retirees, with just enough in their retirement accounts, to undertake this strategy, in the event that it leads to losses. In the even thet were forced to sell their home, they would find themselves with less equity, after paying back the reverse mortgage.
This leads me to my final criticism, which is that taking equity out of your home does not necessarily protect you from a downturn in the real estate market. For example, let’s pretend that you own your $500,000 home outright. After a real estate market crash, let’s assume that you could only sell your home for $300,000. What if you had taken that $200,000 out of your home to invest in stocks and earned a modest real return of $30,000. After selling your home for $300,000 and paying back the $200,000 reverse mortgage, you are left with $330,000, not much more than you ended up with otherwise.
In the end, you have to ask yourself if you think it’s worthwhile to play roulette with your home. For me, the answer to this question is an unequivocal NO.
Since the last few posts dwelt exclusively on the harms and pitfalls of reverse mortgages, it seems that in the interest if fairness, I should shift the focus to some of their positive attributes. For ease of transition, I think it makes sense to debunk a few misconceptions, in order to transform perceived drawbacks into benefits.
The first, and most common myth, is that in entering into a reverse mortgage, you no longer own your home. According to this line of thinking, the bank gives you cash in exchange for the title to your home; the only twist is that you get to remain in your home until you die. In reality, this is simply not the case. A reverse mortgage is equivalent to a lien, which in legal terms, means that another party (the lender, in this case) owns a stake in your home. You still retain title to your home, and in fact, you can return to being the sole owner if/when you repay the reverse mortgage.
Therein lies the second myth- that a reverse mortgage is permanent; once you enter into it, there is no way of exiting. In fact, a reverse mortgage is mechanically no different than any other loan, in that it must ultimately be repaid. Granted, a reverse mortgage is somewhat unique, because you can use the proceeds from the future (posthumous?) sale of your home towards repayment. That doesn’t mean, however, that you can’t simply repay the loan prior to selling the house. Just make sure you read the fine print to understand the terms of the loan, especially regarding possible prepayment penalties.
Yet another myth is that to secure a reverse mortgage, you need great credit, just like when applying for a conventional mortgage. Nothing could be further from the truth. Reverse mortgage lenders couldn’t care less about your personal financial situation. In fact, the whole point of reverse mortgages is to help those most in need of cash, especially those that have no other options. The primary factor in evaluating an reverse mortgage application is the quality of the home that is being mortgaged. The better the home, the better the prospects are for appreciation, and the more money you can borrow via a reverse mortgage. In this sense, the keystone of the reverse mortgage process is the appraisal – not the credit report. Prevailing interest rates and the age of the borrower will also influence the maximum loan size, but are less important than your collateral (the house!).
The final myth is that your original mortgage must first be paid off before entering into a reverse mortgage. Again, this is completely inaccurate. In fact, many borrowers use reverse mortgage for the main purpose of paying down/off their existing mortgage balance. It’s even possible to maintain a conventional mortgage and a reverse mortgage at the same time (though this isn’t advisable in most cases). The FHA, which insures most reverse mortgages, has certain threshold requirements, but these can be bought down with excess cash. In other words, you can dip into your savings to pay down your original mortgage to the level stipulated by the FHA, and then immediately use the funds from a reverse mortgage to replenish your savings account.
There is a tremendous amount of misinformation surrounding reverse mortgages, which means that I could continue. I think I’ll stop here for now, and pick up when I receive some feedback from readers. I invite you to leave a comment if there is an aspect of reverse mortgages that you aren’t quite clear on, and/or there is a myth that you hope the staff at reversemortgage.net can help you shatter!
Let’s be honest. Most products/services have the potential to benefit their users, and reverse mortgages are no exception. For those that desperately wish to remain in their homes but lack other means to do so, reverse mortgages represent a realistic option. At the same time, with every product/service there also exists the potential for scamming and misuse, and again reverse mortgages are no exception.
There is something about the nature of reverse mortgages which makes them particularly prone to fraud. Perhaps it is because borrowers are older than average, and in many cases, elderly and even senile. Such borrowers may lack trusted advisers and may be desperate for cash, which can easily be exploited by scammers. Reverse mortgages also tend to be somewhat more complicated than conventional mortgages, which can also easily be exploited. Finally, the fact that reverse mortgage borrowers never need to write a check to the lender (funds move in one direction) probably leads a sense of complacency.
Moreover, recent government legislation has actually facilitated an increase in fraud, rather than mitigating it. In the late 1990’s, the Clinton administration changed the rules governing the hiring of appraisers, such that they are no longer subject to Federal Housing Administration (FHA) Oversight. Now, they are appointed directly by the lenders. Second, “Congress earlier this year temporarily raised the maximum amount homeowners can borrow against, from $417,000 to $625,500, making the loans ‘more lucrative for misdeeds.’ ”
The first development has been instrumental in reverse mortgage fraud involving distressed real estate, whereby “speculators purchase distressed properties and, with the aid of cosmetic repairs and inflated appraisals, deed them to seniors at above-market prices. Seniors—some of whom may be part of the scheme—typically are promised homes for no money down. In return, they secure a reverse mortgage and divert some, if not all, of the proceeds to the scheme’s promoters.” [The WSJ article from which this description is pulled, details several such scams at length, and is a must read for anyone who harbors suspicions about the propriety of their reverse mortgage.]
As a result, legislation has been proposed which would undo what Clinton effected, making it so all appraisers must be hired directly by the FHA. For those of you with libertarian leanings that are skeptical of any government role in “free markets,” consider that the majority of reverse mortgages are insured by the FHA, which means that taxpayers are ultimately on the hook for any impropriety.
In addition, some lenders have taken measures into their own hands by working to prevent reverse mortgage speculation. Recent rule changes implemented by the biggest lenders require that borrowers must live in a home for at least six month to one year before they can become eligible for a reverse mortgage. This is pretty crazy, when you consider that reverse mortgages are designed to aid older borrowers that presumably have lived in the same home for many years. I guess it shows how opportunism remains widespread, even in spite of the bursting of the bubble.
Marty Bell, Director of Communications for the National Reverse Mortgage Lenders Association, recently authored an articulate and impassioned response to a Consumer Reports article that denigrated reverse mortgages. His manifesto, which was published on Reverse Mortgage Daily, was championed by dozens of readers, who heaped praise on Mr. Bell for bringing the truth to light.
I, on the other hand, was less than moved. It’s clear from Mr. Bell’s response that the original Consumer Reports article did not adhere to the highest of journalistic standards. The report was biased and sometimes erroneous, but I found its criticisms to be eminently reasonable. Moreover, I thought Mr. Bell’s response hewed to an equally strong bias, and perhaps he is equally guilty of committing logical fallacies. Alas, this is not surprising given his position as chief megaphone for the reverse mortgage lending lobbying group. In a nutshell, he represents the producers, and consumer reports represents the consumer.
I would like to offer a rejoinder to Mr. Bell’s response, not necessarily because I believe Consumer Reports was right, but because I don’t believe they were wrong.
1) Based on the data I have seen, reverse mortgage lending is projected to rise by 50% in 2009. In my book, that qualifies as an “explosion.”
2) “The fees and interest charges, which are misunderstood and miscalculated in Consumer Reports, are comparable to any mortgage product,” says Mr. Bell. I would agree with Consumer Reports that the fees associated with reverse mortgages are clearly exorbitant. Regardless of what they are being used to pay for (FHA insurance, in this case) and whether these costs are reasonable/valid, the costs are nonetheless significant, and Mr. Bell does a disservice by not acknowledging this. Interest charges, meanwhile, while comparable to traditional mortgages, seem slightly more insidious, since they are merely subtracted from one’s equity, rather than paid outright, and thus can seem less than they actually are.
3) Contrary to Mr. Berll’s assertion, there are still reports of rampant fraud, abuse, cross-selling, contrary to what Mr. Bell insists. It’s not fair to blame reverse mortgages for the fraud that surrounds it, since every industry is plagued by “bad apples.” Still, it should be acknowledged that questionable practices in reverse mortgage lending are especially prevalent, perhaps because the product is comparatively complicated. It doesn’t help that the number of reverse mortgage lenders has surged, attracting brokers that were formally involved with selling sub-prime mortgages. His response, that “anyone who sells the product inappropriately is taking perhaps the hugest risk of all—ruining their professional reputation,” is quite naive.
4) Legislators are rightfully concerned about such fraud and cross-selling. For the record, John Dugan, Comptroller of the Currency, said “While reverse mortgages can provide real benefits, they also have some of the same characteristics as the riskiest types of subprime mortgages – and that should set off alarm bells.” Does that sound like a “fan of the product?” Dugan’s comments were made not in the context of theory, but against the backdrop of reality. Human nature being what it is, the government has a responsibility to protect consumers both from themselves and from unscrupulous lenders.
5) If housing prices remain low or trend lower, defaults reverse mortgages could certainly become more common. Pessimistic projections or not, this is still a reasonable concern, since it is ultimately taxpayers which will be on the hook.
6) The problem, as Mr. Bell alludes to but does not acknowledge, is a lack of accountability. The FHA insurance system is akin to securitization system which encompasses traditional mortgage lending, in that loan originators bear little responsibility for the consequences of their lending. If the loan goes bad, it is the federal government and private investors that will ultimately be responsible. This doesn’t provide much of an incentive for careful vetting of potential borrowers.
Personally, I think reverse mortgages can be beneficial in the right circumstances. Mr. Bell would have us believe that they are beneficial in almost all circumstances. He doesn’t acknowledge that in return for being allowed to stay in one’s home, a reverse mortgage borrower gradually loses the majority of his equity.
Mr. Bell’s analysis is predicated on the assumption that staying in one’s home at all costs is the best option. A reasonable alternative would be to simply sell the home and move into a smaller, more affordable unit, and/or switch to renting. Of course, for those that want to stay in their homes, reverse mortgage lending remains the best/only option, but perhaps this is an irrational choice.
In short, I think Consumer Reports does deserve some credit for shining the spotlight on the this small-but-growing corner of mortgage lending. Given the “great retirement” that is looming, demand for reverse mortgage will only continue to increase, and it’s crucial that organizations such as Consumer Reports exist to prevent unchecked growth.
With reverse mortgage underwriting volume setting new records every month, perhaps it’s time to take a step back and examine some of the drawbacks of this popular product.
As with many mortgage products that were conjured out of thin air and/or rose to the fore during the housing bubble, reverse mortgages can be exceedingly difficult to understand. On the surface, it seems quite simple. In return for sacrificing some of the equity in your home, you receive payment(s) from a lender, while retaining the right to remain in your home. What could be better?
Unfortunately, reverse mortgages are inherently structured to the advantage of the bank, despite claims to the contrary. For many homeowners, the exchange of future equity for cash now is eminently reasonable, but it still must be pointed out that the trade inherently favors the lender. This is guaranteed through relatively high interest rates and fees, both of which ensure a lower payout.
Many borrowers don’t bother to calculate the cost of the equity they are giving up, since unlike a traditional mortgage, they don’t have to part with any cash until they pass away or decide to sell the home. However, such a calculation is vital in order to confirm that the exchange basis is reasonable. This is especially true if you opt to receive a lump-sump payment, and proceed to invest any leftover in a savings account, which will almost certainly return less than the rate of interest you are “paying” on the reverse mortgage loan.
Be extremely wary of any marketing materials or sales pitches that make promises to the contrary. Unscrupulous lenders will be quick to capitalize on your ignorance, and may resort to questionable arithmetic in order to demonstrate the financial benefits of reverse mortgage. They may further try to combine the reverse mortgage with another financial product, such as life insurance and/or annuities. From a financial standpoint, this is inherently a losing proposition, since the rate used to calculate your reverse mortgage will always exceed the rate used to calculate your annuity payment.
In short, reverse mortgages should really only be considered as a last resort for most borrowers. For those whose retirement accounts have been decimated by the stock market crash and/or need cash now, it’s still a viable option. Just be advised that the terms are weighted against you, equivalent to selling the equity in you home at a discount. Caveat Emptor / Buyer Beware….