What You Need to Know About Reverse Mortgages to Avoid Getting Ripped Off
With 32 million baby boomers on the cusp of retirement—and roughly half of them with little or no money set aside for it—the financial industry is touting reverse mortgages as a legitimate option to help people stay in their homes by borrowing against their equity, often for living expenses.
Reverse mortgages, while they may not be bad financial products in concept, may end up taking advantage of an aging, cash-strapped population that needs to scrounge to find financial resources for retirement.
Many Americans, no longer the beneficiaries of employee pensions and impeded by perplexing retirement savings options, are feeling crushed under the burden of building a nest egg. As a result, just 28% of workers say they’re confident they will have enough money to have a comfortable retirement, according to the Employee Benefit Research Institute.
This is where reverse mortgages come in. No longer is the wealth of home ownership a financial legacy that is passed onto heirs; it's now just another piece of our patchwork retirement system. A home’s equity is increasingly needed for survival with much of whatever’s left going to the bank. And financial experts say that as our population ages, more people are going to need these loans whether we like it or not.
Critics argue that reverse mortgages are an inhumane retirement program, forcing people to deplete their assets just to survive and transferring much of their wealth to the banking industry. And while some reforms have been put in place to protect seniors who opt for this financial product, there are still many potential pitfalls to reverse mortgages that can create unforeseen financial burdens.
Demystifying the Reverse Mortgage
A reverse mortgage is quite a complex loan. It’s structured so that the loan balance will gradually increase over time, so the lender will have a bigger stake in the property each month. The “reverse” part of the reverse mortgage is that the borrower loses equity in the home as the loan progresses.
Meanwhile, the reverse mortgage borrowers can stay in their homes without having to pay their monthly mortgage (they’re still on the hook for taxes and insurance) and they are given money as either a lump sum, line of credit or an annuity, which is borrowed against the equity in the property. They can use the money however they wish, but the banking industry sells “cash outs” as a way for seniors to pay their bills when Social Security, Medicare and nest eggs like 401(k)s and IRAs fall short.
While the amount that can be borrowed depends on the lender, the older the borrower is at the loan’s initiation, the more equity the borrower can access. Likewise, the higher the property’s value, the more that can be borrowed against it. The maximum amount of a reverse mortgage is roughly about 57% of a home’s value.
After the borrower dies, the loan must be settled. This is done either through the sale of the property or with other funds from the borrower’s estate. Heirs are also given the option to arrange financing to keep the home. If the loan amount exceeds the home’s value, the ownership of the house defaults to the lender.
“Reverse mortgages can be fantastic retirement lifeline for millions of seniors,” says Greg McBride of Bankrate.com, an independent monitor of the financial services industry. “They can provide homeowners a regular income stream or a growing line of credit.”
“Some people may not have enough saved in their retirement plans, so much of their wealth is in the equity of their homes. All the reverse mortgage does is give them a way to access those funds,” says McBride.
McBride says that dollar for dollar, reverse mortgages might be a better way of accessing equity than the typical “cash out” sale, where a homeowner sells the property and buys or rents a less expensive dwelling. Fees involved in selling a home can eat away at equity and rents will only increase over the years.
While the number of new reverse mortgages has declined since the housing bubble burst in 2007 (when some 115,000 were issued) there are still some 50,000 homeowners over the age of 62 who opt for them each year and about 600,000 of these loans still outstanding.
The Rebranding of the Reverse Mortgage
A decade ago, reverse mortgages had a dreadful reputation. They were known for their high costs and fees compared to traditional mortgage loans and the media reported horror stories of elderly people losing their homes to foreclosure. Many times, however, the homeowners had failed to pay their property taxes, says McBride, which could happen to any homeowner, regardless of whether they have a reverse mortgage.
In 2006, some federal protections were built into reverse mortgages including financial counseling to help borrowers understand their ongoing financial obligations. Also, the new federal regulations for the loans required lenders to assure that the borrowers have the means to pay property taxes and insurance. Other federal regulations have also kept away predatory lenders that charge exorbitant interest rates that quickly eating away at a borrower’s equity, says McBride.
But consumer advocates still report many pitfalls with reverse mortgages. Richard Cordray, the director of the Consumer Financial Protection Bureau, has said that many seniors are still entering foreclosure at an alarming rate, with one out of every 10 borrowers either in default or foreclosure in 2012, a percentage that has risen from a decade earlier.
Cordray says many seniors still don’t understand the terms of reverse mortgage loans, which gets them into trouble. The problem, he said, is exacerbated by deceptive marketing and scammers. In 2012, Cordray pledged the resources of his government agency to help stamp out such deceptive practices.
The Consumer Financial Protection Bureau has reported that most people who receive reverse mortgages opt for a lump sum over an annuity or line of credit for their reverse mortgage cash-out. The bureau reported to Congress in 2012 that more than 70% of people who obtained a reverse mortgage opted for a lump sum. Borrowers who take the lump-sum payment may be asking for trouble, especially if they outlive the money, which could spell financial disaster if they grow too old to work or care for themselves.
Meanwhile, seniors continue to be scammed by mortgage brokers. In one notable case, a former subprime lender in Chicago sold reverse mortgages to seniors who never saw the cash-outs they were entitled to receive from the transaction.
Another scam involves dishonest lenders working with unscrupulous appraisers to exaggerate the value of the property before the reverse mortgage is obtained, which entices the prospective borrower to take out a reverse mortgage. Once the mortgage is approved, the lender persuades the borrower to transfer the title to them and absconds with funds from the settlement. This leaves the senior without a home and without the cash from the reverse mortgage.
But it’s not always scam artists doing the bilking. Sometimes, legitimate lenders play hardball with the heirs of a deceased reverse mortgage borrower.
Under federal regulations, the heirs to a house under a reverse mortgage are offered the option of settling the loan for a predetermined percentage of the entire amount owed. They also must be given at least 30 days from when the loan comes due to make a decision about the property and six months to provide financing resources to pay off the mortgage.
However, there are reports of reverse mortgage lenders demanding the entire balance of the mortgage to be paid, and giving heirs little time and confusing instructions on how to arrange for refinancing. Some lenders offer the borrower’s heirs few resources to attempt to pay off the mortgages and are foreclosing on these properties in just a few short weeks after the death of the borrower.
The New York Times reports that while there is no data tracking how many heirs of reverse mortgage borrowers are facing foreclosure, senior advocates and housing counselors have told the paper it's a growing trend.
Until recently, couples who took out reverse mortgages in the name of only one spouse ran into trouble when the borrowing spouse died. The surviving spouse had to pay back the reverse mortgage or move out. Because of this, many non-borrowing spouses were forced to give up their homes. But recent changes make it possible for the non-borrowing spouse to remain in the home under certain conditions; however they would stop receiving money from the cashed-out equity of the home.
The Consumer Financial Protection Bureau recommends that both spouses sign a reverse mortgage so the surviving spouse can continue to receive monthly payments or access to the line of credit.
While the CFPB says these new rule changes help protect reverse mortgage borrowers, it insists that these loans are not right for everyone and are risky and expensive. The bureau recommends that if you’re contemplating a reverse mortgage, seek the help you need to make an informed decision about this confusing financial product and do not make any decision regarding your home’s equity hastily.