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A report recently released by the Consumer Financial Protection Bureau highlights some of the changes, risks, and dangers that are developing in the market for reverse mortgages.
The reverse mortgage is a financial product where the homeowner borrows against the equity in his home, without making any payments currently on account of interest or principal. The lender is repaid upon the homeowner’s death, or when the home is sold.
The original idea of the reverse mortgage was to give elderly homeowners (age 62 or over) the opportunity to access the equity in their homes without selling or incurring the obligation to make monthly payments to a conventional mortgage lender. It was expected that most reverse mortgage borrowers would receive and use monthly payments from the lender to pay help pay their living expenses and age in place.
The CFPB report discusses several worrisome and increasing trends: borrowing large lump sums (even when the funds are not needed); borrowing at an early age; homeowners failing to continue to pay insurance and taxes, and thereby risking foreclosure; and borrowers falling prey to deceptive marketing of reverse mortgages.
Borrowers should be cautious of borrowing large lump sums, particularly when the loan is not really needed. Retired seniors who spend the equity in their homes without a sound plan for the future will likely have no possibility of recovering financially. When used as originally intended, the reverse mortgage will deplete the home equity at a slow rate, so that some of the funds will be available when needed later on. Borrowers need to be conscious of the lender’s “loan to value (LTV)” ratios, as typically only 50% – 70% of the home’s market value can be accessed.
A significant and surprising finding in the CFPB report is that the most common age for a reverse mortgage borrower is 62 years, which is when an individual first becomes eligible for a reserve mortgage. These young borrowers have a lot of years in front of them, and borrowing too soon, before the funds are really needed, can have a devastating impact later on. They may find themselves with little resources to meet the financial challenges they will face in later years, including paying taxes and insurance on their home.
Apparently, some of the younger or lump sum borrowers are holding their reverse mortgage proceeds in savings accounts or investing in securities or other financial products. In many cases, interest on savings or investment returns are less than the interest accruing on the reverse mortgage. Of course, investment losses accelerate even further the other problems discussed above.
Another surprising trend is the failure of the reverse mortgage borrowers to continue to pay their insurance and taxes. Approximately 10% of borrowers are in default of this obligation, which could result in foreclosure and a total loss of their investment in their home.
Deceptive advertising and lack of understanding on the part of consumers of this financial product continues to be a problem. Some lenders have portrayed their reverse mortgage loans as a government program or a government benefit. Borrowers need to understand that the reverse mortgage is a complex financial product offered to the public for profit by commercial lenders, and is not in any way a government benefit or entitlement.
In addition, borrowers often seem not to understand or fully appreciate the extent and impact of the various costs involved in a reverse mortgage. Application fees, appraisal fees, bank fees, attorney’s fees, etc., all add to the cost or limit the amount that will ultimately be available to the borrower. Also, depending on the financial institution involved, interest rates may be high relative to other financial products.
While this article warns of some of the dangers of reverse mortgages, this financial product should not be rejected automatically. For many elderly individuals and couples, it can be a viable option for generating cash flow when they are no longer working or when passive income sources do not provide enough to meet ordinary living expenses. If you are thinking about a reverse mortgage, do your homework, and check with a few different lenders before you make a decision. Also, if you need help, your Elder Law attorney can be a valuable source of information and assistance.