In the business world, it is common practice to initiate a product for one purpose, then try to increase sales by marketing that same product to a wider group and, at the same time, changing the purpose. It now seems that reverse mortgages are falling into that category.
Reverse mortgages were initiated some years ago for the purpose of assisting elderly homeowners to live out their later years more comfortably. With a reverse mortgage, homeowners who were strapped for income could not only pay down their existing mortgage, but could also have extra cash to provide for their needs. Now they had no more mortgage payments and the cash to stay in the home for the rest of their lives. The government liked the idea so much that it guaranteed reverse mortgages in a few ways, taking the lender entirely off the hook insofar as risk goes:
o If the value of the home dropped to below the amount of the mortgage, taxpayer money reimbursed the lender.
o If the homeowner failed to pay the taxes and maintain the home, the Government, and not the lender, took the property in foreclosure.
Reverse mortgages were intended to bail out older homeowners. It was a way to allow them to keep and live in their own homes in their old age.
The purpose of reverse mortgages has not changed. It is a good way for elderly homeowners to remain in their homes--but only as a last resort and only when no other avenues exist. A reverse mortgage is expensive and complex--it is not as simple as a conventional mortgage.
According to Consumer Reports, "unsuspecting borrowers have become cash cows for lenders and others who encourage them to use their mortgage proceeds to by financial products such as deferred annuities that can be inappropriate for their situation. And the required counseling can be skimpy." To me, such a practice is reminiscent of what was touted as a "pension-maximization plan" back in the 1980s. Here, a married wage earner was encouraged to choose the higher single-life pension and with the difference (between the higher single-life and lower joint-and-survivor pensions) buy a life-insurance contract on the pensioner. While it may have worked for some who had many options, this was usually a way to sell more life-insurance products.
How does a reverse mortgage work? Only homeowners older than age 62 are eligible. You apply for a loan amount that will pay off the existing mortgage plus some extra to cover living expenses. Of course, maximums apply. According to Consumer Reports, "for a $300,000 home in the New York City area, the maximum available was $152,074 for a 64-year-old and $182,541 for a 74-year-old." So, even if the amount received is only enough to pay off the existing mortgage, just this relief from monthly mortgage payments can tip the balance in favor of the homeowner's staying in the home.
Fees for reverse mortgages are not like those of conventional ones. Fees are steep and are added to the loan amount up front. In addition, interest rates are usually adjustable, and the interest simply keeps getting added to the loan amount over time.
A reverse mortgage is just a mortgage, so the homeowner still continues to own their home--as long as they maintain the property and pay the taxes. When the homeowner dies, the mortgage must be repaid and the home can go to your heirs. But what if the mortgage amount exceeds the value of the home and there are no funds in the estate to pay down the mortgage? The property is foreclosed and then owned by the government, not your heirs.
Reverse mortgages are an expensive way to pull money out of a home for purposes other than day-to-day living expenses. Not for lavish spending--and certainly not for investing. Consider what would happen if you took a reverse mortgage and spent or lost the extra funds. Would it be enough to live in a house without any mortgage payment? Could you afford the increasing taxes and maintenance?
Some things work well on paper with simple illustrations and assumptions. Real life adds the complications that were never considered in the simple illustrations. Before signing up for a reverse mortgage, it would be a good idea to seek the advice of a trusted friend or counselor--or an independent financial adviser. A reverse mortgage can be just the right product for those in dire straits and nowhere else to turn. But for those with somewhere else to turn, it would be better for them to do so.
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