In the last few months I’ve written some positive columns about reverse mortgages. I promised to follow-up with their downsides. That’s how I found myself at Senior Source in Dallas, listening to staffers in the Elder Financial Safety Center.
Senior Source knows all the bad things that can happen to retirees. The organization is the first line of defense for people in Dallas who might otherwise become victims of financial fraud, high-pressure sales, or all the other things that separate older people from their savings.
But let’s start with the basics. The idea of reverse mortgages has been around for more than half a century. It started when researchers saw that the largest pool of savings most Americans had was the equity in their homes. It still is.
A reverse mortgage is the opposite of the mortgages we all know. Those are the ones where we borrow a sum and pay it back, with interest, in 360 easy payments.
In a reverse mortgage, the cycle works the other way. You can borrow against your home equity in a lump sum, ad hoc payments, or lifetime monthly payments. Every dollar you take out is tax-free because it’s your money and you’ve already paid taxes on it. But taking it out means it will earn interest for the lender.
Since you don’t pay the interest charged, the debt grows, month by month, reducing your equity. Loan origination costs, insurance, and basic interest rates exceed the cost of conventional mortgages. So many regard reverse mortgages as expensive sources of cash.
“It’s the flip side of compound interest,” Steve Benton observed, “and it’s working against you. Your equity is being consumed. If you live any amount of time, your equity will be gone.” (Steve Benton is a financial counselor at the Elder Financial Safety Center.)
“This is just the next piece of candy for baby boomers,” Deborah Burkham said. She works with Benton as an assessment coordinator. “What has amazed me is how slow they (lenders) are to foreclose. They don’t move quickly, but when they do, it’s messy.”
I asked who would be a poor candidate for a reverse mortgage, and who would be a good candidate.
Ms. Burkham said unemployed people approaching age 62 and looking forward to Social Security were poor candidates. It was worse if they had significant health problems. If their health forced them to leave their home early, she explained, the loan would be a bad idea because of the high front-end costs.
Another bad reason to take out a reverse mortgage was to pay for a grandchild’s education, pay another’s debt, or help a friend. Most people took out reverse mortgages because they didn’t have a good alternative. So borrowers weren’t in a position to use the money to help others.
A good candidate, Steve Benton noted, was someone with no heirs. Anticipating a shorter life expectancy was another plus. Having a great need for immediate extra cash to cover living expenses was also good.
With a dark laugh, we all agreed on the ideal reverse mortgage candidate. It was a good deal for someone who took lifetime monthly payments, lived to 100 and owned a house where property values tanked. A good example would be someone who took out a reverse mortgage on a Cape Coral, Florida home in, say, 2007--- just in time for the crash.
The opposite, it turns out, is what many reverse mortgage customers expect. “In a counseling session,” Ms. Burkham noted, “one of the questions we ask is what do they expect will happen?
“Many believe their equity will increase. What I explain is that their loan is earning 5 percent a year, but their home is appreciating at 3 percent.”
The result? The more money borrowed, the faster the homeowner will hit the wall--- the largest amount they can borrow. That, all agreed, is when the real problems start.
That's when homeowners can’t borrow more money and don’t have enough income to pay for basics. Some, for instance, fail to pay real estate taxes. Or home insurance. Or home maintenance. That’s when they’re likely to force a foreclosure, losing their home and any equity in it.
As this is written, Senior Source is working to help a 73-year old woman with this problem. She took out a reverse mortgage, spent the available cash, and is now facing foreclosure because she hasn’t paid her real estate taxes.
Does this mean reverse mortgages are a menace to society, as some paint them? No, but they need to be used properly.