Until recently I didn’t understand the specifics of a reverse mortgage (the majority of which are HECMs – Home Equity Conversion Mortgage) well enough to answer that question. I’d seen sufficient ads by Tom Selleck, Alex Trebek, and Henry Winkler to know that these famous TV personalities, with a net worth of $45 million, $75 million, and $30 million, respectively, (Celebrity Net Worth, 2019) endorse them. Do the endorsements mean that reverse mortgages are a good option for the average retiree whose major asset is his home? Is borrowing against that asset late in life a good idea? I wasn’t sure.
What benefits can reverse mortgages provide?
I attended a class presented by a lender whose firm provides reverse mortgages. His presentation was upbeat and largely positive. From his perspective reverse mortgages provide a great opportunity for seniors who are cash-strapped and want to tap into the equity they’ve built into their home. He stressed the fact that reverse mortgages provide tax-free money. The borrower has options about how to receive the payments and how to use the funds. Payments from a HECM loan can be used to defray the costs of long-term, in-home care.
Are there disadvantages to reverse mortgages?
The lender’s representative pointed out a few negatives associated with reverse mortgages. First, HECMs are expensive loans to get. The interest rate for a HECM is slightly higher than that for a regular mortgage. Reverse mortgages are also subject to the normal costs—origination fees, servicing fee, and third-party fees—associated with home loans. A key difference with HECMs is that they also incur the cost of mortgage insurance for the entire length of the loan. This amount is set by HUD. The current charge is .5% of the loan balance.
A second disadvantage of reverse mortgages deals with the payment of the taxes and insurance associated with the loan. The loan itself is not due until the homeowner dies or is no longer using the home as his or her primary residence. However, homeowners are required to keep current with their insurance and tax payments. Failure to pay puts the homeowner at risk of losing the home.
Are reverse mortgages really logical?
I listened carefully and jotted copious notes. To me the whole concept seemed illogical. Cash-strapped homeowners at least 62 years of age--and likely on a fixed income--take out a long-term loan against the equity in what is probably their only asset with a chance to appreciate in value. This seemed unreasonable and dangerous. Beyond that, I wondered how elderly borrowers who needed a loan to meet living expenses or help family members now could be confident they could repay the loan—with its accruing interest—if they had to leave their home for health or personal reasons. They weren’t likely to have additional earning power over the course of the loan. As they aged, their health-related expenses would likely increase, eating up a larger portion of their fixed income. How would they keep up with other expenses? What would happen to their home if they couldn’t stay current? How would their heirs be affected?
Is there another side of the reverse mortgage coin?
A bit of Internet research revealed that, indeed, there is. The negatives can be huge—and devastating. Numerous articles cited examples of elderly borrowers facing foreclosure because of back taxes they were unable to pay. In August 2017, The Washington Post ran an article entitled “More Seniors Are Taking Loans against Their Homes — and It’s Costing Them.” Besides providing examples of reverse mortgage tragedies, the article quoted a HUD report from 2016 that contained some startling statistics. “More than 18 percent of reverse mortgage loans taken out from 2009 to June 2016 are expected to go into default because of unpaid taxes and insurance," according to that report. This rate is more than 6 times the foreclosure rate of traditional mortgages, according to HUD spokesman Brian Sullivan. Mr. Sullivan also stated that the HUD reverse mortgage portfolio “was valued last fall at negative $7.7 billion.” Wow!
What’s being done to slow the default rate?
In 2019 the FHA issued new rules to address the abnormally high default rates for reverse mortgages. Lenders must now submit their appraisals for reverse mortgages to the FHA for a risk collateral assessment before they start the loan origination. If, during the risk assessment, the FHA flags the loan as one that contains potential bias, they require a 2nd appraisal to be done. As a precaution against inflation of value, the FHA requires the loan origination amount to be based on the lower of the 2 appraisal values.
The FHA is now reviewing reverse mortgage stats for the fiscal year that ended in September of 2019. The results of their review may spur further changes.
So, are reverse mortgages good for most homeowners?
No, I can’t see that reverse mortgages help average homeowners, despite lenders and celebrity endorsers who say otherwise. If your home is your highest-valued asset, it’s your single best hedge against economic difficulties you might face as you age.