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.
