Government: Beware of Reverse Mortgages

In a recent speech and accompanying press release, Comptroller of the Currency (”OCC”), John C. Dugan, warned the public about reverse mortgages: “While reverse mortgages can provide real benefits, they also have some of the same characteristics as the riskiest types of subprime mortgages — and that should set off alarm bells.”

Given that reverse mortgages have exploded and are now growing at a record pace (perhaps the only mortgage product for which there is increased demand) due to the economic downturn, increased attention from regulators was inevitable.[Chart below courtesy of WSJ].

As with traditional mortgages, reverse mortgages have been fraught with abuses, such that the drawbacks are de-emphasized, and many mortgagers don’t fully understand the terms of what they are getting themselves into.

Let’s review the basics: “Reverse mortgages or Home Equity Conversion Mortgages (HECM) are designed for mature Americans over the age of 62 to use their current homes as collateral for a home equity loan. Instead of receiving a loan and having to pay it back within a certain time frame a reverse mortgage pays the borrower for staying in their home…A reverse mortgages gives borrowers the ability to either receive monthly payments to help with their current monthly income; a lump sum to pay-off bills and possibly their current mortgage; draw a line of credit for as needed money; or a combination of all three.”

In theory, reverse mortgages represent a great way for those approaching retirement (or already retired) to tap into the equity of their home, minus the loan amortization. Of course, the loan must ultimately be repaid when the mortgager moves or passes away. While there is little or no risk of bank foreclosure (only in the event of extreme disrepair), there remains the risk of foreclosure precipitated by failure to pay property taxes. However, this risk exists even in the absence of a reverse mortgage, and I don’t personally think it represents a consideration.

The main concerns are twofold: upfront fees and conditional mortgaging. First, since the nature of the reverse mortgage is such that the mortgager never pays the bank directly, there is the tendency to overlook large upfront fees, which are simply rolled into the mortgage. The FHA, which insures 90% of reverse mortgages, has\ attempted to crack down on this abuse by imposing fee cap- both a fixed $6,000 cap, and as a percentage of the total loan value.

Second, many reverse mortgages are being marketed in conjunction with other products, such as annuities. In some cases, seniors are encouraged to sign up for additional services; in other cases, they are a condition (i.e. compulsory) of receiving the mortgage. According to the OCC, “With access to large lump sums upon closing, elderly borrowers can be particularly vulnerable to coercive sales of annuity and long-term care insurance products that are expensive and may not be appropriate to their needs.”

Still, that’s not to say that reverse mortgages are inherently harmful. As with most financial products, they are advantageous for some, and inappropriate for others. Generally speaking, for those with little savings (a common phenomenon in the wake of the stock market correction) and/or outstanding mortgages, a reverse mortgage represents a reasonable way to stay in your current home. Of course the adage that “There is no such thing as a free lunch” still applies, since you implicitly forfeit most of the equity in your home.