If you, your relatives or friends are contemplating applying for a reverse mortgage in 2010, check out the new guidelines proposed this month by the federal regulatory agencies for financial institutions.
Though aimed at banks and credit unions, the guidelines neatly sum up the potential snares and pitfalls for consumers in the fast-growing reverse mortgage field. Reverse mortgages typically are restricted to homeowners 62 and older who have untapped equity available in their real estate and want to turn it into cash.
Borrowers can receive lump-sum payments, credit lines, periodic disbursements or a combination. The funds drawn down incur interest charges and fees for insurance and servicing, which generally must be paid back only after the occurrence of a so-called "maturity event" — when the borrower sells, moves, dies, fails to make property tax and insurance payments, or allows the house to deteriorate substantially.
When properly understood by seniors and underwritten responsibly by lenders, reverse mortgages can provide money to supplement retirement income, pay for uninsured medical expenses and keep homes in good repair. But all too frequently, the regulators said, seniors are poorly counseled in advance and don't comprehend what they are getting into.
They are misled by direct-mail pitches that imply that reverse mortgages are a "government benefit," cost relatively little, never need to be repaid, represent "income for life" and carry "no risk." In fact, reverse mortgages often entail high up-front origination fees and substantial insurance and servicing charges — well beyond the costs associated with other financing alternatives that may be available to seniors, such as home equity loans, credit lines, sale-leaseback plans and deferred-payment loans.
Banks and credit unions need to spell all this out for seniors in advance of taking reverse mortgage applications, said the regulators. This is a financial product that requires extra time and personal financial counseling up front — not only because the applicants are elderly but because reverse mortgages themselves are inherently complex.
As to being a "government benefit," they are not. Though the predominant form of reverse mortgage is the HECM or Home Equity Conversion Mortgage insured by the Federal Housing Administration, the loan itself comes from private lenders. Those lenders, not the borrowers, are insured by the government against loss.
Some borrowers are not even aware that the transactions they sign up for are debt instruments requiring repayment. Lenders' marketing materials may make that problem worse by glossing over the payback requirements. "In fact," the regulators said in their guidance, some lenders' marketing material "has prominently stated that the consumer is not incurring a mortgage, even though the fine print states otherwise." Other lender problems noted by the regulators include:
• Inappropriate cross-selling of additional financial products, sometimes presented as a requirement for the borrower to obtain a reverse mortgage. These include costly annuities, investment programs and home-repair service contracts. Often these products eat up a significant portion of the money being drawn down via the reverse mortgage, and leave the borrowers without adequate funds "to meet emergency needs or to pay ordinary living expenses." The regulators' recommendation to lenders tempted to cross-sell high-profit products to poorly counseled seniors seeking reverse mortgages: Don't do it. Not only is it unfair to the applicants, but their subsequent financial weakness could come back and haunt you later.
• Failure by banks to explain the potential downsides of reverse mortgage payment alternatives to applicants up front. For example, some lump-sum payout options may be inappropriate for certain seniors because they adversely affect their ability to qualify for needs-based public benefits, such as Supplemental Security Income. Lenders should tell applicants about these dangers, rather than letting them blunder into the wrong program choice.
• Failure to inform borrowers up front about their own responsibilities under reverse mortgage contracts. For example, there may be no escrow account attached to a reverse mortgage, something borrowers might assume is standard, based on their experience with regular home mortgages. Yet without an escrow that pools money to pay for local property taxes and hazard insurance, reverse mortgage borrowers may not remember to pay those bills themselves, risking foreclosure and loss of the home.
The regulators' message to banks: Explain all the working parts of the loan up front, and make sure the borrowers fully understand what they've got to do on taxes and insurance, and by when.
The same advice should apply to seniors and the family members: Research and understand all the financing and estate planning alternatives available to you — plus the inner mechanics of the various reverse mortgage options — well in advance of making an application.
Ken Harney can be reached at [email protected]