The Truth About Reverse Mortgages
Beware of the pitfalls of reverse mortgages
illustration by victoria marcelino
You’ve seen the ubiquitous TV ads, the ones with mature celebrities Pat Boone, Robert Wagner, Henry “Fonzie” Winkler and Fred Thompson extolling the virtues of a reverse mortgage for homeowners 62 and older.
Thompson, the avuncular television and movie actor and former US Senator and Republican presidential candidate, assures you that, with this “government-insured, tax-free and safe loan,” you can take cash out of your home, have no monthly payments and still own your home.
It’s not only that simple, he infers; it’s the yellow brick road to a financially carefree retirement.
“There’s got to be a catch, right?” asks the pitchman for AAG Insurance Company while staring directly into the camera. “Well, there isn’t.”
Umm … not so fast, Fred.
It turns out that, for some, a reverse mortgage can be much more of a risk than a remedy.
“The closing costs are very exorbitant and there are no two ways around that,” says Paul McLaughlin, who manages the home ownership and counseling education program at NeighborWorks of Southern New Hampshire’s Home Team, which is a collaborative of three agencies including CATCH Neighborhood Housing in Concord and the Area Community Land Trust in Laconia.
“The way that [these insurance companies] lure people in is by saying that they’re not paying these costs out of their pocket. The philosophy is that someday you’re going to die and somebody else will pay it off when they sell the house. Luckily, we don’t always die, and then it’s a lot of tearing into your earned equity,” McLaughlin says.
Nevertheless, with more federal regulations and protections put into place in the past few years, this type of loan is increasingly popular with seniors who want to supplement their income or use their home’s equity now.
But reverse mortgages are still complicated and confusing.
The only reverse mortgage insured by the federal government is called a Home Equity Conversion Mortgage, or HECM, and it is available solely through an FHA-approved lender, according to the US Department of Housing and Urban Development.
There is so much fine print and so many devils in the details that potential borrowers are now required to attend informational sessions with a federally certified HECM counselor, and then they have to pass a quiz in order to move forward in the process.
To help seniors sort through the terms and understand all of the specific information, AARP has even published a 36-page educational booklet, “Reverse Mortgages: “Borrowing Against Your Home.” (The online version is aarp.org/revmort.)
For the basics, you have to be at least 62 in order to qualify for a HECM, you must own your home outright and live there as your primary residence, or you can carry a mortgage small enough to be paid off by the proceeds from a sale if you move or die. If there are any funds left, they can go to your heirs.
In the meantime, your loan doesn’t have to be paid back until you or the last co-borrower dies, moves out permanently or sells the home. Since there are no monthly payments to make, there are no income or credit qualifications, although homeowners are responsible for paying all of the annual property taxes, property insurance and maintenance costs.
But beware that if at any time you fall behind on the insurance premiums and/or property tax payments, and in some cases the maintenance expenses, your reverse mortgage is deemed to be in default and the bank or lender has the right to foreclose on your home. Once your home is in foreclosure, you can be evicted.
“The biggest question people have is ‘What happens if I can’t pay my taxes and insurance? Who do I turn to if I’m running into problems?’” says McLaughlin. “You have to understand all of the expenses involved. Just because this loan might pay off your mortgage, you still have those other line-item responsibilities in that house.” He adds that the agency’s certified counselor, Debbie Wheeler, is an invaluable resource for anyone considering this home financing option.
Financial experts agree that a reverse mortgage is a bad choice for seniors who have assets in addition to the equity in their home. Moreover, it is reckless to use one to pay for luxury items and extravagances that won’t add to the home’s value.
But for cash-strapped and struggling seniors who are worried about keeping the roof over their heads and the wolf away from the door, they can be the lifeline.
“For some people this is an amazing program that can allow them to age in place. It allows those folks who purchased homes responsibly and built up equity over the years to be able to tap into that and have it support them through their golden years,” says McLaughlin. “If somebody has worked all their life, has enough equity in that property and is living on Social Security alone, and they don’t have funds to cover medical expenses, transportation and whatever else they need to maintain healthy living, then why not? It’s a win for them. That’s part of the American dream.”
But to keep this form of financing from turning into a nightmare, seniors need to be as educated as possible on any potential pitfalls and problems.
They should inquire about origination fees, interest rates, monthly service fees, private mortgage insurance and third-party costs that need to be covered. If considering an adjustable-rate HECM, it’s important to ask about the “margin.” It’s also important to know that a lump-sum draw can end up costing a lot more in the long run.
Moreover, they should never allow anyone to talk them into borrowing more than they need, especially with the promise of lower up-front fees.
“Be meticulous when doing your homework and in your preparation. I recommend that you bring your spouse with you to counseling sessions and, if there isn’t a spouse, bring a friend or trusted advisor to listen because your mind is working overtime and you’re not going to hear everything. You’re thinking of your immediate needs at that moment,” McLaughlin says. “These mortgages serve a great purpose in our world and there are people who can hugely benefit from them. But there are those who use them who don’t really need them. Make sure you understand what you’re getting into.”