Article by Investment U
You may have seen the commercials featuring “The Fonz,” or Henry Winkler, peddling reverse mortgages. If not, you can see it here:
You can throw former Presidential candidate Fred Thompson and actors James Garner and Robert Wagner in the mix, too.
The spokesmen certainly make these products sound enticing. They promise cash now as a financial cure-all while in retirement. But these spots never go into much detail about what exactly a reverse mortgage entails.
It’s “so easy,” but does it come with some severe possible costs? If you or your parents are looking at this process as an option, I’m about to cover what you’ll need to take into consideration.
What Exactly is a Reverse Mortgage?
Reverse mortgages are available to homeowners over the age of 62 and it gives them the ability to convert their home equity into cash while still living there. It differs from a regular mortgage in that you’re not paying down principal so that your home equity is increasing.
The reverse mortgage gives you your home equity as a payment, which raises your debt and decreases equity. Thus, it’s called a reverse mortgage.
The most popular form of this loan is the Home Equity Conversion Mortgage (HECM). It’s administered by HUD and insured by the FHA.
So when would you need to repay this loan? When the homeowner dies or moves out for good, the loan is settled usually through the sale of the home. If the mortgage is more than the market value of the house, the FHA makes up the difference.
Here’s the Catch…
So there’s a mortgage product that people don’t understand? Go figure…
On the surface, this seems like a pretty good way to get some cash out of your house. It’s kind of like refinancing.
But here’s the catch. The newly formed Consumer Financial Protection Bureau (CFPB) – which came out of the Dodd-Frank legislation – is now in charge of all mortgage regulation. Congress gave the CFPB the charge to investigate the reverse mortgage industry and see if there were any shady or deceitful practices going on.
What it found in its report was that the product was too complex for the majority of seniors to comprehend.
“Reverse mortgages are complex and have the potential to become a much more pervasive product in the coming years as the baby boomer generation enters retirement,” said CFPB Director Richard Cordray. “With 1 in 10 reverse mortgages already in default, it is important that consumers understand what they are signing up for and that it is the right product for them.”
Some found it hard to grasp the concept of the increasing debt and decreasing equity aspect of the loans. Others didn’t even get that the product is really a loan. These are serious red flags as we come out of a period where people entered into mortgages they didn’t really understand – and we’re still reeling from its results today.
Defeating the Intended Purpose
Let’s dive a little deeper into the report…
The report validates some previous concerns about the risks to borrowers. The product, as I’ve stated before, is very complex. But with the commercials and celebrity spokesman, seniors just see it as a means to a quick payday. And more of a growing issue is the way in which the number of borrowers is expanding. One of the real issues is that the age of the borrower is getting younger.
Almost half of the borrowers last year were under the age of 70. Many of these borrowers were using funds to pay off regular mortgages rather putting it to meet present day bills. If some financial crisis pops up, you’re tapped out if that was your last resort.
Another issue is in how you take your payment. Seventy percent of borrowers are opting for large lump sum payments at a fixed rate rather than going for the more flexible lines of credit with adjustable rates.
Wait a minute! Wasn’t it those adjustable-rate mortgages (ARMs) that got everyone in trouble a few years back?
Yup. However, that holds true for regular mortgages. But remember that these are reverse mortgages. A fixed-rate reverse mortgage pays an upfront lump sum of the entire amount you qualify for. This usually means higher interest costs and a more rapid depletion of equity.
Megan Thibos, a policy analyst in CFPB’s mortgage markets group and principal author of the report, states, “The lump sum loan leaves you with no flexibility or cushion… If you take an adjustable rate line of credit and fail to pay your taxes or insurance, the lender can process a payment from your line of credit. But that’s not possible if you’ve taken it all upfront.”
Worst-Case Scenarios
What’s really scary about this product is that they can create some really bad situations for the investor and his family. Here’s what could happen:
- If the borrower needs nursing home care in the future, there could be a big problem. The deal works as long as they live in the home. If the borrower has to move out of the home into an assisted living arrangement or a nursing home, that reverse mortgage is now due.
- If a senior couple takes off a spouse from the property’s title because they aren’t the qualifying 62 years of age, there can be devastating repercussions. If the older spouse dies or is put in a home, the younger spouse could lose the home.
- In a similar circumstance, if an older spouse leaves off the younger to qualify for a higher loan amount (the amount of the loan is tied to the borrower’s age) then their death or admission to a nursing home could cause the loss of the house.
- The previous two points also apply to any non-borrowing family members who live in in that home, such as children or grandchildren.
- All principal, interest and fees have to be paid in full for the lender to give possession of the home to any rightful heirs. If they can’t pay up, the house will be foreclosed on. If your heirs are cash-strapped, your home may not be a part of any inheritance.
As you can see, this is no product to jump into without due diligence. Not only could you lose your home, but it could be lost for spouses and family members. A reverse mortgage may be one of those products only necessary as a last resort.
Good Investing,
Jason
Article by Investment U
