The Deal with Reverse Mortgages

Reverse mortgages have been advertised more and more during the recent run-up in home prices, but not every senior is a good candidate for one.

There have been a lot of radio and TV ads touting reverse mortgages, especially featuring Fred Thompson, the former senator and presidential candidate. And more so since the recent run-up in home values. So what’s the deal? Why haven’t we heard more from our advisors and the press?

The basic idea is that seniors desiring to supplement their incomes take out a mortgage on their home that replaces the one that they have now. The difference is that while you continue to pay real estate taxes and insurance (including mortgage insurance), you no longer have a monthly mortgage payment.

But, wait, as the ads say, there’s more!

You either get a monthly check, a lump sum pay out, both drawing down your home’s equity, or you may opt for a credit line against it. And the kicker is that you continue to live in your home. That’s a powerful draw for many seniors. What’s not to like? Why doesn’t everyone do this?

Not so fast, Mr. My Equity Is Growing Back Now And I Want Access. First of all, the Federal Housing Administration, which, wisely or not, insures these loans, requires that you are at least 62 years old. One big reason is that the interest (and up to $6,000 in loan origination fees wrapped into the loan) compounds in your account and your equity might vanish in only 10 to 20 years. Then you will have to move. Or if there is another real estate downturn you might have to move sooner when the lender forecloses because the presumed equity has vanished, just as in 2008 to 2010.

But there are some safeguards. At 62 years, you are limited to a buy-out of only 40% of your equity, and at 72 years the number rises to 60%. Your heirs, should you actually die while in your home, have some rules to protect them—although, there has been a history of lenders making the maze of confusing regulations even more impenetrable. A recent investigation by the US Government Accountability Office found that 7 of 15 lenders studied were not in compliance with disclosure requirements, for instance.

To put this all in perspective, it is estimated that 5% of eligible homeowners might be good candidates for reverse mortgages, but only 2%, or 775,000, currently hold them. The current loans average about $150,000. Two-thirds have used the money received to pay down debt and only a quarter have actually put the money into lifestyle spending.

It turns out that the public considers reverse mortgages to be a “last resort” and a “quick fix” for indebtedness. Indeed, most of the current holders of such loans are from “low-income, poor health” households that have nowhere else to turn. So, as you might imagine, the default rate on reverse mortgages is about 10%, or double the usual rate, which makes interest rates higher.

To summarize, reverse mortgages have a place—a small place—in the pantheon of financial options for seniors. Between their higher rates and fees, they are relatively expensive, and they are complicated, both in increasingly regulated theory and in opaque, sometimes abused, practice.

But, if you are a senior in need of cash flow and own your own home, it might be worthwhile to speak to a neutral financial advisor knowledgeable in such matters before you might speak to a salesman. As in all things money: caveat emptor.