Despite what you may have read and heard, reverse mortgages are not inherently evil. At least, I don’t think so. Rather, there is a tremendous amount of misinformation surrounding them, which has created the perception that somehow they are the province of scammers and opportunists. While this generalization is unfair, there are certainly some practices that push the limits of honesty and run contrary to the “spirit” of the product. I have culled a handful of these, below.

First of all, there is the misconception that reverse mortgages are originated directly by the government, or even worse that they are a “government benefit,” on the same level as social security and medicare. On the contrary, all reverse mortgages are issued privately. While the vast majority are insured and regulated by the government (via FHA), this is quite different from saying that they are administered by the government. For all intents and purposes, then, they are private products with private contracts.

Other misconceptions arise from erroneous comparisons with conventional mortgages. For example, some borrowers fail to grasp that a reverse mortgage is still a mortgage, in that it accrues interest and must be repaid. Other borrowers step too far in the opposite direction, and assume that some of the up-front fees will be used to fund an escrow (like with a conventional mortgage), that will in turn be used to make insurance and property tax payments. On the contrary, it is the responsibility of the borrower to continue making such payments as usual; failure to do so could ultimately lead to foreclosure. Along the same lines, other borrowers have taken out reverse mortgages to make simple repairs on the home, when a (government-subsidized) conventional mortgage might be cheaper, and more appropriate.

One of the most common pitfalls, meanwhile, is to borrow more money than necessary under a reverse mortgage. Not only will that cause a faster erosion of home equity (due to the accrual of interest on a larger balance), but thus could also render one ineligible for certain social-security benefits that otherwise could have been obtained. It’s important to understand that money not withdrawn (such as with a line-of-credit payout option) does not accrue interest. Another pitfall (one might be tempted to use scam, but this isn’t always illegal) is to use the proceeds from a reverse mortgage to “cross-purchase” (the counterpart to “cross-selling) another financial product. Many lenders have earned the ire of consumer advocates and government regulators for cajoling borrowers into buying annuity agreements and other insurance products when closing on a reverse mortgage. That’s because such products are rarely – if ever – appropriate for reverse mortgage borrower, who are advised to rebuff this cross-selling.

Finally, there are the outright scams. Surprisingly, research has shown that most scams are perpetrated not by lenders, but by third parties and family members. Lenders could perhaps be faulted for not being vigilant enough when it comes to policing scams (in fact, they are actually incentivized not to report them), but the primary fault rests not with them. Some con artists, for example, persuade borrowers to obtain reverse mortgages in order to pay for products/services that they are selling. Another elaborate scam involves the reverse-mortgage-for-purchase, in which the victim receives the house, and the scammer takes the proceeds from the mortgage. Finally, there are plenty of cases of adult children blatantly stealing from their senile parents, by taking out reverse mortgages without their knowledge/understanding.

Thankfully, most of these “practices” can easily be prevented, simply through increased information. Reverse mortgages have very niche uses, and should only be obtained only as a last resort. Principal and accrued interest must be repaid after a maturity event (death, moving out, failure to pa taxes and maintain the property, etc.). They should be obtained under one’s own volition – and not under duress – and they should be structured so that the funds received are spent almost immediately, but not frivolously. Any questions?