Is a reverse mortgage a good way for seniors to improve cash flow or solve other financial problems?
This type of loan allows older homeowners to borrow against their home's equity with no restrictions on how the money gets used and no obligation to pay it back while they're in the home.
Being able to get back the money you’ve paid into your house sounds great, but homeowners should be aware of the risks these loans carry.
There are two primary lines of attack against this type of loan: Seniors aren't using such loans how they were originally intended, and they aren't getting the quality information they need to make a good decision on what's right for them.
Let’s examine four reasons to be wary of reverse mortgages.
Reason 1. They aren't being used as they were intended — to supplement retirement income.
This type of loan was conceived as a way to help borrowers without sufficient retirement income meet their expenses, allowing them "to age in place," the Consumer Financial Protection Bureau wrote in a June 2012 report to Congress.
That's not happening in many cases.
|Borrower age||Borrower must be at least 62.|
|Maximum loan||51% to 77% of the appraised home value based on age, type of loan|
|Mortgage insurance premium||Upfront: 2%; ongoing: 1.25% of outstanding loan balance per year.||Source: Consumer Financial Protection Bureau|
Instead, many borrowers are using the infusion of cash to pay off their existing mortgage debt. Those considering a reverse mortgage are about 10 percentage points more likely to owe at least a quarter of their home's value than other homeowners their age, the CFPB study found.
Especially for relatively young seniors in their 60s, this poses risks.
"While they gain additional cash flow (that previously was going to mortgage payments) for a period of time, they lose the ability to use their home equity as a cushion against other major expenses in retirement, such as needed home repairs or medical expenses," the CFPB study authors note.
Indeed, borrowers often turn to reverse mortgages because they don't have enough income to pay their home loan, says Jim Pucher, a counselor with HUD-authorized ClearPoint Credit Counseling Solutions based in Richmond, Va.
Using your home's equity in this manner fails to address a fundamental problem: "Some borrowers may simply be prolonging an unsustainable financial situation," the CFPB says.
In this case, downsizing might be the better option, Pucher says. It could result in more manageable upkeep and lower overall costs. If you go this route, you can still take advantage of record-low mortgage rates.
Reason 2. People are tapping too much of their equity up front.
Whether you take out one of these loans to pay off your existing mortgage or other debts, the risk remains the same: You could have too little equity left over to fund your retirement or a down payment if you need to move later.
Or you could simply be digging a bigger hole.
"If they are paying off significant credit card debt but have not changed their behavior, then they may find they simply end up with more debt and no home equity," says Letha Sgritta McDowell, a certified elder law attorney with Oast and Taylor in Virginia Beach, Va.
There are a couple of ways you can get access to the money you're borrowing: a lump sum, in equal monthly payments or in varying amounts on an as-needed basis.
If you opt for equal monthly payments, you know the money will be there as long as you live in the house. Not so when it comes to a lump-sum payment, which is the option most borrowers choose.
|Death||The lender may demand the loan be paid off when you or the last co-borrower dies.|
|Vacancy||The loan can be called if you move out of the home permanently.|
|Extended absence||The loan can be called if you don't live in the home for more than a year due to illness or other reasons.|
|Selling the home||The loan can be called if you sell or give the home via a title transfer to someone else.|
|Neglecting obligations||The loan can be called if you fail to pay taxes, insurance or keep the home in good condition.||Source: Consumer Financial Protection Bureau|
Reason 3. You could lose your home.
Some sales pitches claim there's no risk you could lose your home. This isn't true.
You must stay current on property taxes, homeowners insurance premiums and property maintenance. Seniors who don't meet these obligations can face foreclosure.
Keep in mind, if you keep on top of these obligations, you should be fine.
What’s more, the most common type of reverse mortgage, the FHA’s Home Equity Conversion Mortgage (HECM), has a built-in system for helping seniors avoid losing their homes for these reasons.
When a borrower falls behind, the FHA requires the mortgage servicer to pay the outstanding charges, then try to bring the borrower current through strategies such as establishing a repayment plan of up to 24 months, connecting the borrower with free financial counseling or even refinancing the loan.
The FHA also has to approve of the servicer's loss mitigation attempts before the servicer can foreclose.
Another problem, and something Pucher says his counseling clients most often have trouble understanding, is that adding a nonborrowing spouse to the title is not the same as adding a spouse to the loan.
If both spouses are not on the loan and the borrowing spouse dies first, the nonborrowing spouse will be required to sell the home or pay off the mortgage debt.
A number of spouses who have outlived their partners have lost their homes as a result.
Reason 4. It's hard to make an informed decision.
These are complex products that offer borrowers a variety of options. Knowing, for example, whether to take out a fixed-rate or adjustable-rate loan, or whether to take your money all at once, aren't obvious choices.
What's more, government agencies are concerned that advertisements for this type of loan have only confused borrowers about the risks, even though applicants are required to attend counseling.
"Counseling may be insufficient to counter the effects of misleading advertising, aggressive sales tactics or questionable business practices," according to the CFPB.
Pucher says the government requires reverse mortgage counselors to follow a specific protocol to identify the client’s needs and circumstances, loan features, borrower responsibilities, fees, financial and tax implications, alternatives, and insurance fraud schemes and elder abuse.
He says counselors also discuss whatever considerations they find appropriate for each client’s unique situation.
But the counseling’s effectiveness depends not only on the quality of the counselor but on logistics.
Pucher says some states require in-person counseling, but borrowers can’t always find an HECM-certified counselor in their communities.
McDowell says telephone counseling is sometimes the only option, because many seniors are homebound and counselors will not go to seniors’ homes. But if the senior has a hard time hearing, phone counseling may not be effective.
She adds that counselors don’t always explain the product well.
Seniors should seek appropriate advice from an attorney or well-qualified financial adviser, McDowell says.
"Without planning, the seniors may find that they are in no better financial position after taking the mortgage than before," she says.
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