Even though an unfortunate few have lost their entire life savings, are reverse mortgages a “sure thing” when it comes to senior citizen investments?
By: Ringo Bones
Many card-carrying AARP members swear by it as having boosted their “nest egg” when they were introduced to it back in the early 1990s while an unfortunate few has had their entire life savings wiped out, but nonetheless, many ageing baby-boomers do swear by it as the long-term investment that managed to boost their existing nest egg pool. But are reverse mortgages truly the sure thing Wall Street savvy financial advisers tout them to be or is it just something where ageing baby-boomers blinded by greed met their financial downfall during the 2008 global credit crunch?
A reverse mortgage is a home loan that provides cash payments based on home equity. Homeowners normally “defer payment of the loan until they die, sell or move out the home.” Upon the death of the homeowners, their heirs either give up ownership to the home or must refinance the home to purchase the title from the reverse mortgage company. Specific rules for reverse mortgage transactions vary depending on the laws of jurisdiction.
In a conventional mortgage, the homeowner makes a monthly payment to the lender. After each payment, the homeowner’s equity increases by the amount of the principal included in the payment. In a reverse mortgage, a homeowner is not required to make monthly payments. If payments are not made, interest is added to the loan’s balance. Although the “rising loan balance can eventually grow to exceed the value of the home, the borrower or the homeowner’s estate is generally not required to repay any additional loan balance in excess of the value of the home.” In Canada, the loan balance cannot exceed the fair market value of the home by law.
Regulators and academics have given mixed commentary on the reverse mortgage market. Some economists agree that reverse mortgages allow senior citizens to smooth out their post retirement income and consumption patterns over time and thus may provide welfare benefits. However, regulatory authorities – such as the Consumer Financial Protection Bureau – argue that reverse mortgages are “complex products and difficult for the average consumer to understand, especially in the light of misleading advertising, low-quality counseling and risk-of-fraud or other scams”. Moreover, the Consumer Financial Protection Bureau claims that many consumers do not use reverse mortgages for the positive consumption-smoothing purposes advanced by economists. In Canada, the borrower must seek independent legal advice before being approved for a reverse mortgage.
Reverse mortgages have been criticized for several major shortcomings: 1) High upfront costs make reverse mortgages expensive. IN the United States, entering into a reverse mortgage will cost approximately the same as a traditional FHA mortgage. 2) The interest rate on a reverse mortgage may be higher than a conventional “forward mortgage”. 3) Interest compounds over life of a reverse mortgage, which means that “the mortgage can quickly balloon”. Since most monthly payments are made by the borrower on a reverse mortgage, the interest that accrues is treated as a loan advance. Each month, interest is calculated not only on the principal amount received by the borrower but on the interest previously assessed to the loan. Because of this compound interest, the longer the senior has a reverse mortgage, the more likely it is that most or all of the home equity is developed when the loan becomes due. That translates to “less cash for your estate or to pay for your bills.” That said, with the FHA insured HECM reverse mortgage, the borrower can never owe more than the value of the property and cannot pass on any debt from the reverse mortgage to their heirs. The sole remedy the lender has is the collateral, not assets of the estate, if applicable. 4) Reverse mortgages are confusing. Many seniors entering into reverse mortgages don’t fully understand the terms and conditions associated with the loans and has been suggested that some lenders have sought to take advantage of this.
46 percent of seniors understood the financial terms of the reverse mortgages very well when they secure their reverse mortgage. In the past, government investigators and consumer advocacy groups raised significant consumer protection concerns about the business practices of reverse mortgage lenders and other companies in the reverse mortgage industry. But in a 2006 survey of borrowers by the AARP, 93 percent said their reverse mortgage had a mostly positive effect on their lives compared with 3 percent who said the effect was mostly negative. Some 93 percent of borrowers reported that they were satisfied with their experiences with lenders and 95 percent reported that they were satisfied with the counselors they were required to see.