With all the negative publicity surrounding reverse mortgages these days, even I sometimes forget that for some people, they can still be very helpful. I’ve previously written about how reverse mortgage proceeds can be used responsibly to pay expenses associated with home-ownership (i.e. property taxes, insurance, maintenance/renovation). Below, I want to explain how they can also be used responsibly to pay off existing mortgage debt.

It’s actually pretty straightforward. In fact, when you apply for a reverse mortgage, it’s not even necessary to indicate what the proceeds will be used for, which means you don’t have to worry about filling out additional forms if you plan to use the proceeds to pay off your primary mortgage. You simply obtain the reverse mortgage for the amount of principal outstanding on your primary mortgage (plus the fees associated with the reverse mortgage), and deposit the funds in your checking account, and mail a check to your mortgage server. Voila! You now no longer have a primary mortgage.

Of course, you first need to make sure that your reverse mortgage will be large enough to cover the outstanding balance of your primary mortgage. The maximum loan amount depends on a number of factors, namely your age, prevailing interest rates, and the appraised value of your home. Simply, consult this matrix of FHA HECM loan limits, and multiply the applicable percentage to the value of your home. Unfortunately, the FHA continues to lower these limits (in order to protect the solvency of the HECM program), and if your primary mortgage exceeds 50% of the value of your home, you probably won’t be able to obtain a reverse mortgage that is large enough to completely pay off your primarymortgage balance. What’s more- most lenders won’t issue you a reverse mortgage if you still have an outstanding primary mortgage, and the upshot is that you will need to wait a few years and/or hope that your home appreciates in value.

The merits of obtaining a reverse mortgage to pay off a primary mortgage are certainly debatable. On the one hand, reverse mortgages are inherently expensive, and if you obtain a large reverse mortgage (relative to the value of your home) and use all of the proceeds to pay off your primary mortgage, you probably won’t have much equity left in your home after 20 years.  On the other hand, most financial planners will tell you that it’s wise to pay off all of your debt shortly after entering retirement, since your incoming cash flow will be minimal, and may not be enough to cover your debt service obligations. If you accept this line of reasoning, then obtaining a reverse mortgage could be the most straightforward (if the not the only) solution to paying off your primary mortgage will still remaining in your home.

Just remember that there is no free lunch, and that the payments that you otherwise would have been making on the primary mortgage are now accumulating in the form of unpaid interest/principal under the reverse mortgage, and will need to be repaid when the borrower moves out or passes away.

These days, the media has been harping on foreclosure, but very little of the attention is being directed towards reverse mortgages. While newspapers and TV newscasts have been filled with reports of foreclosure “victims,” one has to search long and hard for victims of reverse mortgage foreclosure. This is probably for good reason, since the fraction of conventional mortgages that have slid into foreclosure is significantly higher than the corresponding proportion of reverse mortgages.

Unfortunately, this could change soon, as Reverse-Mortgage-Daily recently reported that “HUD has given lenders approval to foreclose on seniors whose properties have gone into ‘technical’ or other default.” The news posting goes on to argue that foreclosures would be bad for the reverse mortgage industry (mainly from a PR standpoint), and that specific guidelines will be issued later this spring.

Regardless of what HUD decides, foreclosures in reverse mortgages will remain rare. That’s because reverse mortgage contracts (as mandated by HUD) are written in such a way as to preclude foreclosure in all cases except where the borrower has failed to pay property taxes, homeowners insurance, and/or failed to adequately maintained the property. There are also a handful of contingencies in which the loan can be called (namely when the borrower dies or moves out), which also results in the lender taking control of the property unless the balance of the loan is immediately repaid.

In practice, technical default remains rare, in part because the reverse mortgage itself represents a source of funds which can be used to pay taxes, insurance, etc. In addition, lenders remain reluctant to foreclose on reverse mortgages (even when they may be legally justified to do so) not only because of the negative PR but also because there is no incentive to do so. That’s because reverse mortgages are insured, and lenders can be assured (in most cases) of collecting the full balance of the loan when it comes due, including back-taxes and homeowners insurance.

Even if the value of the home declines dramatically, a foreclosure would still not be justified. That’s because the home is only appraised when the reverse mortgage is first issued and if/when the borrower wants to refinance or extend the loan term. If the home depreciates in the interim, even to the point that the balance of the loan exceeds the value of the home, HUD (not the borrower) must remunerate the borrower using funds from its insurance reserves.

In short, this change in policy probably won’t amount to much. It’s a reasonable attempt by HUD to make sure that its HECM reverse mortgage program remains viable. Unfortunately, the biggest threat to its solvency is not borrowers not paying property taxes, but rather, a continued decline in home prices. And there is very little HUD can do to mitigate this possibility (except to further increase insurance premiums for borrowers) without fundamentally altering the current structure of reverse mortgages.

It seems that HUD is finally ready to authorize HECM reverse mortgage for Co-Ops. According to one source, “it has redrafted a mortgagee letter that would permit HECMs on co-ops and is awaiting final approval.”

It was initially expected that HECM reverse mortgages would be available to co-op owners by the end of 2008, but delays have begotten more delays, and here we are well into 2010. [Admittedly, HUD has had its hands full managing the housing crisis, but even so!]. In the meantime, angry homeowners have been writing to Congress and to newspaper columnists, trying to get the timetable pushed forward: “Can you believe…Washington’s ridiculous delay in officially authorizing reverse mortgages for co-ops? So many senior citizens have been misled and hurt by this.”

Currently, owners of condominiums and other forms of cooperative housing that otherwise would qualify for reverse mortgages have very few options. They can go through private lenders, but these mortgages are not insured by the FHA and tend to be more expensive and carry higher interest rates. Reputedly, there is at least one reverse mortgage lender that offers HECM reverse mortgages on coops, but its terms and loan limits are more restrictive than with HECMs on conventional properties.

With full FHA approval, lenders could presumably be more aggressive in offering reverse mortgages on coops. Previously, lenders were put off from doing so because of uncertainty over the implications over a co-owner defaulting on a primary mortgage as well as difficulty in appraising the properties (which is required to calculate the maximum loan amount). As one columnist explained to an exasperated homeowner: “lenders are reluctant to allow you to take equity out of your place through a reverse mortgage when your neighbor — who, like you, contributes to the upkeep of the overall building — might default on his mortgage at any time?”

Even if the FHA gives the go-ahead, co-op owners must first solicit the approval of the building administrator. According to an insider, such requests will be rebuffed “maybe 20 percent of the time.” Still, this would represent an improvement over the current situation.

Still a small fraction of overall lending activity, reverse mortgage scams appear to be rising in number.

Forbes reports that “Criminal cases are popping up all over involving reverse mortgages, particularly in states, hardest hit by the bursting of the housing bubble. Earlier this month, two people were arrested in Atlanta and charged with trying to profit off a government loan insurance program by posing as real estate agents and luring seniors into fraudulent reverse mortgage loans using altered real estate records and fake documents.” Other scams have apparently  incorporated loan modifications.

Fortunately, cases of outright fraud remain rare. However, stories of misinformation and poor counseling are  commonplace. Reverse mortgage lenders might not understand that they have a fiduciary responsibility to their borrowers. Many lenders adhere loosely to this notion, but in fact, the Federal Trade Commission (FTC) requires all lenders to convey both the benefits and drawbacks of reverse mortgages and to advise their clients accordingly when a reverse mortgage may not be appropriate.

Having learned some strong lessons from the housing boom and bust, the federal government is no longer sitting by idly. Through the Federal Financial Institutions Examination Council (FFIEC), an all encompassing regulator of financial institutions, the FTC is working to “advise lenders of the importance of not making deceptive claims for reverse mortgages and to provide them with concrete guidance as to the circumstances under which claims may be deceptive in violation of Section 5 of the FTC Act.”

In addition, the FTC is trying to form a, “federal-state working group to strengthen law enforcement efforts against illegal practices,” as well as “consumer and business education efforts, such as including a revised consumer brochure, ‘Reverse Mortgages: Get the Facts Before Cashing in on Your Home’s Equity,’ a new business alert to help housing counselors spot and report potentially deceptive claims, and presentations to reverse mortgage industry groups.”

Still, the FTC is mainly effective in punishing fraud – not preventing it. The burden is still on you, the borrower, to be vigilant. If it smells fishy, walk away, or at least seek a second opinion. And lastly, if it seems too good to be true, it probably is.

In the last few weeks, something incredible has happened: one after another, reverse mortgage lenders have been eliminating their monthly service fees!

Most lenders typically charge around $30 per month to borrowers for as long as the reverse mortgage is outstanding. This might not seem like a lot, until you consider that over 20-30 years (plus interest), these small monthly fees can exceed $10,000. These fees are part and parcel of the allegations that reverse mortgages are needlessly expensive for borrowers and excessively profitable for lenders. Besides, given the high-upfront costs of reverse mortgages, and the fact that the monthly “servicing” involves the computerized generation and mailing of a statement to the borrower, it’s a fee that’s difficult to justify.

For that reason, MLS Reverse Mortgage of Auburn, California, became the first lender to officially eliminate its monthly servicing fee. A handful of other lenders quickly followed suit, and the (publicized) total is now four. Call it a cheap publicity stunt, a strategic move to gain a competitive edge, or even a sincere effort to respond to critics; regardless, the move has been greeted positively by consumer advocates and borrowers. Not only will borrowers save money over the life of the mortgage, but these savings will translate directly into larger borrowing limits of $5,000+ for an average borrower.

Theoretically, the elimination of monthly service fees shouldn’t come with any strings attached. Still, it’s important to read the fine print and do some comparison shopping to make sure that lenders that no longer charge service fees haven’t offset this by raising their interest rates. If all else being equal, one lender charges monthly servicing fees while another doesn’t, it will make choosing a lender all the easier.

Given that reverse mortgages are already becoming a commodity product, one would expect that all of the (large) lenders will soon follow suit. However, there may be some delays, especially in the short-term, and it wouldn’t hurt to ask your lender to consider dropping these fees in order to gain your business.

Much of the criticism heaped on reverse mortgages is focused on the idea that proceeds tend to be used for inappropriate purposes, such as paying credit card debt, vacations, and other “luxuries.” But what if proceeds were used for “legitimate” needs, such as long-term care and other age-related necessities. Would there still be reason to object?

This was the topic of a provocative piece I read by Howard Gleckman, Senior Research Associate at the Urban Institute, entitled “Public Reverse Mortgages and Long-Term Care: Can They Work Together?” Gleckman argues that private reverse mortgages are flawed because the are expensive, complex, and give borrowers too much discretion in how proceeds are spent, putting them at risk for future financial peril. The solution, he concludes, is to initiate a public reverse mortgage program, whereby the costs of long-term care would be advanced to the elderly, at low interest rates and with their homes as collateral. Presumably, this program would be inexpensive and transparent, as well as serve an important social function.

Whether you agree with the idea of the government entering the “business” of reverse mortgages, you can’t help but see the rationale behind Gleckman’s analysis. I, myself, have argued that reverse mortgages seem to be inappropriate for a substantial portion of the borrowers that ultimately obtain them, many of whom have better options and/or no real need for the money they provide. It still bothers me that reverse mortgages are inherently expensive, but if the proceeds are used for non-frivolous purposes, my objections would basically fade away.

As for what constitutes a non-frivolous expense, that is open to debate. Gleckman suggests that, “You could use the money to make your home wheelchair accessible, or pay for a special van, or even for adult day care or that home health aide.” He adds that, “You’d have far more flexibility than with regular Medicaid. In return for this upfront cash, your heirs would repay the state with modest interest after you die, usually by selling your house. The state wins by saving the cost of caring for you in a nursing home.” For those that want to remain in their homes for as long as possible, this represents an excellent compromise, regardless of whether the lender is public or private.

In fact, this is arguably why reverse mortgages were initially conceived – not to help baby boomers live affluently even in retirement, but rather to fund the cost of certain unavoidable medical and other expenses that are associated with getting old. As Gleckman bemoans, “At the same time, a troubling number of users are relatively young borrowers who are tapping reverse mortgages to pay off credit cards or fund vacations. The perverse result: They will have even less home equity available when they really need it to pay for long-term care.”

When obtaining a reverse mortgage, it’s important to understand not only your obligations, but also your rights. The right (actually a requirement) to counseling is already widely known, but here’s another one for you: the Right of Rescission.

Often referred to as a cancellation clause, the Reverse Mortgage Right of Recission is just that. If for any reason, you are unhappy with your decision and/or wish to cancel the reverse mortgage, you have 3 business days to do so. That’s 3 days after you’ve already signed the documents and have technically already obtained the reverse mortgage. Best of all, there are no penalty fees associated with such a cancellation. The lender must return all of the closing costs, minus any interest on any funds that you have already received.

Of course, most borrowers wouldn’t go through the trouble of obtaining a reverse mortgage only to exercise this right of recission. If you have any doubts, it’s best to work through them before you sign the paperwork and obtain access to the funds. Still, there’s always the possibility of getting wrapped up in the false idea of “free money” and only after the fact understanding the implications of what you’ve agreed to. We’ve all heard stories about aggressive marketing practices and exploitation of seniors. Thanks to the cancellation clause, this is less of a concern since family members (and the borrowers, themselves) can undo the decision after-the-fact.

If you wish to exercise your right of recission, simply contact the lender in writing within 3 business days of closing on the mortgage. Send the request using certified mail and save a copy for your records. “Once the lender receives your notification they have 20 days to return any unused funds after they have retained a portion for the financing you received within the three-day window.” Any reputable lender should honor your request, though it’s still a good idea to confirm ahead of time that this clause is included in the mortgage contract.

If you believe your rights as a borrower have been violated and/or wish to report fraud, you can file a complaint with Federal Trade Commission. You can do that online at ftc.gov or by phone at 1-877-FTC-HELP (1-877-382-4357).

This was the title of a recent article by Jack Guttentag, the self-styled Mortgage Professor. And when the Mortgage Professor Speaks, people listen; his column has been reverberating around the blogosphere for over a month, and now it’s my turn to weigh in.

The crux of Mr. Guttentag’s argument is that there is nothing to compare reverse mortgages to, so it’s ultimately impossible to determine whether they are too cheap or too expensive. Still, he points out that the closing costs seem reasonable compared to other mortgage products, and that the most expensive component is the FHA mortgage insurance premium which is necessary to keep the program financially viable. Guttentag concludes by arguing that on a short-term basis, reverse mortgages are hardly economical, but on a long-term basis, the upfront costs can be rationalized, and at prevailing rates, the current APR is a modest 5%.

In my opinion, this final conclusion is really the only one that actually stands up. Even without doing the math, it’s obvious that any mortgage (conventional or reverse) is not cost-effective if you intend to repay it within a few years of obtaining it. And generally speaking, the longer you hold it, the more economical it is. This is not in dispute.

The Mortgage Professor’s first two points, however, are a bit more dubious. Beginning with FHA insurance premium, this IS both expensive on an upfront (~$4,000) and annual (~$300) basis. Because reverse mortgages are inherently risky from a lender standpoint, the practice of insuring them makes perfect sense. Just because it’s necessary, however, doesn’t mean it shouldn’t be a consideration when analyzing the costs of a reverse mortgage. If you obtain a reverse mortgage, it needs to be paid, but if you don’t obtain one, then of course you don’t need reverse mortgage insurance. This might sound like a tautology, but it’s still a point worth making.

Finally, since there is no product comparable to an HECM reverse mortgage, it’s true that it’s impossible to say whether it’s cheap relative to other reverse mortgages. Still, we can say with near certainty that it’s probably going to be cheaper than any other alternative that doesn’t involve an institutional lender. Borrow money from friends? Cheaper. Sell your current home and buy a smaller one? That’s cheaper, too. Save money by simplifying your lifestyle? Definitely cheaper. Ask your heirs (especially if they want you to keep the home) if they can lend you money using the same structure as a reverse mortgage? Probably cheaper, too.

If you still want to obtain a negatively amortizing home equity loan with high upfront costs and pay interest on interest (aka a reverse mortgage), know that it will be cheaper than borrowing money with your credit card. Compared to almost anything else, however, it will cost you more.

As part of the ongoing overhaul of the reverse mortgage industry, HUD (via the FHA) has revamped the test that counselors are required to pass before they can work with prospective borrowers. According to the front lines, the test is quite hard!

Some background: HUD reverse mortgage rules clearly stipulate that borrowers are  “required to receive consumer information from an approved HECM counselor prior to obtaining the loan.” Previously, this session was treated as perfunctory (it probably still is by many participants), as counselors breezed through a list of caveats and pitfalls to prospective borrowers. These sessions were (and still are, to some extent) conducted by phone, often involving individuals other than the actual borrower.

There were many reports of abuse and conflicts of interest (counselors were using their positions to refer customers to specific lenders on a commission basis), which the General Accountability Office (GAO) identified in a recent report, completed after participating in 15 interviews on an undercover basis. As a result, the rules were tightened, and the counseling requirements enhanced. Prospective borrowers are now encouraged to complete the session in person and must sign an affidavit stating that they understand the risks, etc.

In addition, the certification test for counselors has become more difficult, to the extent that even veteran counselors are finding it difficult to pass. The result is not necessarily that unqualified counselors will be prevented from counseling, but rather than all counselors should be more knowledgeable in the both the benefits and drawbacks of reverse mortgages, and should be able to pass this on to potential borrowers.

From the standpoint of borrowers, this means that the counseling session should theoretically be more useful. If you are even considering obtaining a reverse mortgage, you may as well as undergo counseling as early as possible in the process, before you have committed (either psychologically or to a lender) to going forward. This way, you can fully weigh what the counselor tells you, and make a better-informed decision afterward. If you wait until right before you sign the documents to complete the counseling session, you risk treating it as perfunctory, since it won’t possibly be able to influence your decision.

From the standpoint of counselors, meanwhile, you had better study hard!