What’s the Truth About Reverse Mortgages?

Chances are you’ve seen one of the television commercials featuring former Senator Fred Thompson as a spokesperson for reverse mortgages. He’s also appeared on Law & Order and in countless films. His familiar face is one reason American Advisors Group hired him to advertise their reverse mortgage product to seniors 62 years and older.

In one commercial, Thompson says, “It’s been a few years since I began talking about AAG and reverse mortgages, and since then, AAG has helped thousands of American homeowners convert the equity in their homes into money they can use right now. I know personally how a reverse mortgage can help a family, maybe a family like yours.”

It sounds appealing, but—what’s the truth about these mortgages?

First, they’re not easy to understand. Regular mortgages and the reams of paperwork that accompany them are hard enough for the average consumer to deal with, but throw in the technical points of one in reverse, and we’re left shaking our heads.

Simply put, a reverse mortgage is a home loan that provides cash based on home equity. Home equity is the difference between a home’s fair market value and the outstanding balance of all liens on the property. In a reverse mortgage, homeowners are paid their equity in the form of a loan, which only comes due when the borrower dies, sells the house, or moves out of the house for more than 12 consecutive months. The loan may also become due if the borrower fails to pay property taxes or fails to maintain home insurance.

At any rate, once the loan comes due, the borrower or heirs have the option to refinance the home and keep it, sell the home and cash out any remaining equity, or turn the home over to the lender completely. An attractive feature is that a reverse mortgage is a non-recourse loan, meaning that the lender can only be repaid from the proceeds of the sale of the home, either when the homeowner decides to sell or their estate sells the home. A reverse mortgage is not a loan that can be called or demanded at the lender’s discretion.

Thus, this type of mortgage is attractive to seniors who have built up quite a bit of equity in their homes and see the benefit of using that money for retirement needs, as well as satisfying their strong desire to remain in their home for the rest of their lives.

Single purpose reverse mortgages can be used for one purpose that is specified by the government or nonprofit lender. Federally insured reverse mortgages, or Home Equity Conversion Mortgages (HECMs), make up 90 percent of all reverse mortgage loans. Proprietary reverse mortgages are private loans underwritten by the companies that market them and may require loan counseling. The counseling fee can be paid from the loan proceeds, but you cannot be denied the loan if you can’t afford the fee. All three types of loans can vary in origination fees, interest rate, mortgage insurance and other closing costs; origination fees for HECMs are set by law. Lenders may charge servicing fees during the life of the loan.

Generally, reverse mortgage proceeds are paid as cash or a credit line, distributed in different ways, or a combination of methods. These include a lump sum, in cash, at settlement; a monthly cash advance, for a fixed term or for the owner’s life; or a line of credit, similar to a home equity line of credit.

A variation of HECMs is the HECM for Purchase, which allows a borrower to purchase a new home and apply for the reverse mortgage at the same time, eliminating the need for a second closing. This provision was approved by the Housing and Economic Recovery Act of 2008.

Keep in mind that government investigations and consumer advocacy groups have raised significant consumer protection concerns about the business practices of reverse mortgage lenders and other companies in this industry. The concerns center on companies taking advantage of seniors and their lack of ability to understand the reverse mortgage loan process. But in this country, the Federal Housing Authority requires seniors to undergo credit counseling before taking out these loans. And in a 2006 survey, 93 percent of AARP members who obtained a reverse mortgage reported having a positive experience with the counseling process and their lenders.

To further protect seniors, FHA implemented a financial assessment for reverse mortgages in March. Lenders are now required to do much more comprehensive credit, income and asset underwriting. Lenders will look at credit reports, unpaid property taxes and other signals to determine a “willingness to pay.” Borrowers could see set-asides for items such as property taxes and homeowner’s insurance.

Reverse mortgages are predicted to grow at a rapid pace as our population ages, but as with all loan products, the buyer must be knowledgeable and understand exactly what they are purchasing. If you or a family member are considering taking this step, investigate thoroughly before you sign.

Sources: aarp.org, consumer.ftc.gov and bankrate.com.