Demonizing Reverse Mortgages

Introduction: First, for full disclosure, I have no special like for reverse mortgages. In my nearly six years in the mortgage business, I have done exactly zero reverse mortgages. This is mostly due to demographics, marketing, and the nature of the business over the last six years. That said, I have studied them and so I can analyze them with expertise. Furthermore, the article I will reference attempts to demonize reverse mortgages much the way sub prime, stated loans and no money down loans have been demonized. This is very dangerous business especially when those concepts are demonized by being distorted. I have no problem, and in fact encourage, major newspapers to explore concepts like reverse mortgages. I have no problem even with so called advocacy journalism like the piece I will reference, however when that advocacy is done without setting the proper context, it distorts reality. That, I have a problem with. The thousands of folks that read this piece likely walked away not wanting anything to do with reverse mortgages. That is a shame because many of them could have been right for it.

Here is the piece. First, the piece does something that I have found more and more troubling with regards to mortgages and financial vehicles in general. The story centers around an individual, Ernestine Boach, who had a bad experience with reverse mortgages. There are nearly one million reverse mortgages currently in the United States and so isolating one is exploitative and misleading. Worse than that, the problems with this particular reverse mortgage were never placed into context. Here is an important part...

After her husband died, Ernestine Boach felt she needed financial guidance. It was 2003, and Boach had just turned 62. An adviser urged her to take out a reverse mortgage, available mainly to those 62 and older, and use the money to buy deferred annuities.

"He told me that he had a wonderful deal for me," she says.

It turned out to be a huge mistake. Boach wasn't well-suited for a reverse mortgage, which is a loan against home equity that doesn't have to be repaid until the owner dies or sells the home.

The estate repays the loan, plus interest and fees. The home is typically sold to make the payment.

But Boach had planned to leave her home to her daughter.

There are several problems here. First, there is no reason why the home must be sold by the heirs. In fact, the structure of the reverse mortgage provides so that any responsible individual can easily hold onto a home after taking over a reverse mortgage. Here are some things that the piece didn't say about reverse mortgages. First, the reverse mortgage only goes to 52% of the value of the home maximum. Thus, a home worth 200K would only get a loan up to 104K. Second, the heirs have up to a year to either refinance or sell. Keep in mind that the reverse mortgage gives a loan up to 52% of the original value of the home. By the time the borrower passes away, the loan to value is likely even less. That means the heirs need to refinance a home where the loan is likely less than half the value of the property. Now, for anyone not familiar with loans, that is a very low loan to value and thus makes refinancing the home much easier.

Ms. Boach's daughter could have and should have been able to refinance the property. There was absolutely no reason why she would have been forced to sell. The article alludes to the idea that most reverse mortgages wind up being sold. There are no stats to back this up, and even if this is true, it is done as a choice not as a force.

The article continues to mislead with these next points...

As Boach learned, it isn't always a wise idea, especially during the early retirement years. There are other ways to draw income out of a home, such as a home equity loan, that are cheaper and more flexible, experts say.

The amount you can borrow in a reverse mortgage hinges on your age, the home value and interest rates. The older you are, the more you can borrow. Yet the average age of borrowers is falling.

...

Still, reverse mortgages tend to be costlier than other home loans. The FHA's loan typically charges an original fee of 2 percent of the home value and a mortgage insurance premium of 2 percent. There are title searches, appraisals and other costs, too.

Say, for example, a 62-year-old Michigan woman with a home value of $250,000 applies for an FHA "HECM 100" loan. The total fees and costs would be $11,410. So the loan amount that the borrower is qualified for, $127,556, would be reduced to $116,147, according to World Alliance Financial, a provider of the HECM and other reverse mortgages.

First, there is no doubt that reverse mortgages are significantly more expensive than other loans. That is a drawback, however there is no perfect loan. It is of course misleading to say that reverse mortgages have costs like title because all loans have those. Second, and much more importantly, to claim that home equity loans are more flexible is also misleading. Home Equity loans are traditional loans and thus whatever is borrowed must be paid back monthly. A traditional thirty year mortgage causes the borrower to pay back roughly three times the amount borrowed over the life of the loan. Thus, if someone borrows 100k, they will wind up paying back about 300k over the life of the thirty year loan. If someone is struggling with their monthly bills a traditional HELOC will eventually wind up being an albatross and contribute to the problem rather than resolve it. While a traditional HELOC can also put hundreds of thousands in folk's pockets, they also come with hundreds if not thousands of new monthly payments. This is of course not explained in the article.

A reverse mortgage has no monthly payment. While this is mentioned in the piece, it isn't mentioned until later and no context is provided. While HELOC's are described as more flexible and less costly, the most obvious drawback isn't put into context. The traditional purpose of a reverse mortgage to provide much needed cash to those folks without savings but plenty of equity in their homes. If you are without savings, it is much better to take out a reverse mortgage than it is a HELOC. A HELOC would bring with it a payment that again would eventually become a burden. If an individual or couple has nothing but social security but could also qualify for a reverse mortgage that would infuse them with six figures in cash that doesn't need to be paid back by them, wouldn't the reverse mortgage be a good vehicle for them. This sort of scenario isn't presented in the piece. Rather the piece does this...

Reverse mortgages traditionally have been used by older retirees to pay health care bills. But younger people tend to use the money to pay off credit card debt or pay down their mortgage, according to the AARP national survey.

Those may be good reasons for taking out a reverse mortgage. But one thing has caused much concern: Too often, retirees are urged to use the loan to take out a deferred annuity, which typically provides high commissions to salespeople.

And deferred annuities "are almost always inappropriate for seniors, as they can tie up retirement savings far beyond one's life expectancy," Sen. Herb Kohl, D-Wis., said during a recent congressional hearing on reverse mortgages.

Now, I don't know much about deferred annuities, and I don't know if they would be a good reason to take out the reverse mortgage. If a reverse mortgage is used for the wrong purpose, it is the fault of the advisor not the mortgage. By putting this into a piece that demonizes it in several other ways, it only goes to reinforce in the reader's mind that it is a bad idea. Keep in mind that there are NO investment vehicles that haven't been abused by unscrupulous professionals. Had the piece focused strictly on the dangers of using reverse mortgages for deferred annuities, that would have been one thing. This piece used their misuse in deferred annuities as one of several examples of the dangers of reverse mortgages. All of this would have been fine as well if the piece had merely provided some context by pointing out the proper use of reverse mortgages. It didn't and thus by only focusing on its dangers it causes most readers to dismiss the idea out of hand, even if they may need for legitimate reasons.

Furthermore, the article says that mysterious experts claim that HELOC (home equity loans) are more flexible. This is another sneaky, and ultimately unprofessional maneuver. Who are these experts for instance? Am I not an expert? Most of the folks that I know that understand reverse mortgages don't find them less flexible than HELOC's. What about this flexibility? This is another vague word. Everyone wants a flexible loan however the article needs to show specific examples of flexibility. For instance, most of the reverse mortgages I know of allow for a lump sum payment, a monthly payment plan, or an open line to be tapped as necessary. Isn't that flexible? How are HELOC's so much more flexible?

Conclusion:

The way I describe a reverse mortgage is it is what it is. It is a mortgage that has a lot of costs. It does force your heirs to deal with an extra layer of difficulties with your estate, however it is unique in that it provides you with cash without having to make a monthly payment back. There are perfectly good reasons to take out a reverse mortgage as well as plenty of dangers and any article that only focuses on one and not the other is doing a disservice to the reader.