Warnings on Reverse Mortgages

We have to wave a yellow flag on reverse mortgages. While good ways for some seniors to tap their home equity, they also are a new and fertile ground for fraud, and new rules make them less attractive.

Reverse mortgages are available to people age 62 and older. You receive cash, a stream of payments, or a home equity line. No payments are due during your life as long as you continue to own the home. Interest on the loan and expenses accrue. The lender is paid from the sale proceeds when the home eventually is sold.

Because the lender doesn’t know when the loan will be repaid and what the interest will accumulate to, only a fraction of the home’s value can be borrowed. A borrower in his early 70s, for example, could borrow about half the home’s value.

The older the borrower, the greater the percentage of the home’s value he or she can borrow. Most reverse mortgages are insured by the FHA and must follow its rules. These include limits on the value of the home involved, fees for insurance, and a requirement that the borrower be counseled before closing.

There has been tremendous growth in reverse mortgages in recent years, and unfortunately that is attracting crooks. There are several types of scams involving reverse mortgages making the rounds.

? Loan agents keep the money. The broker who arranges a reverse mortgage or the title company – whoever is in charge of receiving the loan proceeds and transferring it to the right person – pockets the money. This is easy to do when the borrower was using the reverse mortgage to pay off the regular mortgage or other debts. The borrower might not know for some time the money was stolen.

? Family members take from the older generation. Most frauds and thefts against seniors are perpetrated by family members who are supposed to be helping. In some cases a family member who has charge of a senior’s finances arranges a reverse mortgage and converts the proceeds to personal use.

? Home sellers use reverse mortgages to cheat buyers. The crooks obtain foreclosed homes at low prices. They make some cosmetic changes and obtain inflated appraisals. Then, the convince seniors to buy the homes for no money down with reverse mortgages. The crooks take the loan proceeds as full payment for the house and leave the seniors without money in an overvalued home with a large debt against it.

Some reverse mortgage lenders are adding safeguards to prevent or spot the common frauds. But the best protection is for seniors to pay careful attention to details themselves or be helped by someone they can trust, either a family member or a financial professional.

Meanwhile, reverse mortgages are becoming less attractive. The decline in home values combined with high foreclosure rates put a big dent in the reserves of the Federal Housing Administration, which insures both reverse mortgages and conventional mortgages. The FHA also is projecting homes to appreciate less than it has in the past, which also hurts it reserves.

The result is new rules that allow homeowners to borrow less from a new reverse mortgage than they would have before new rules took effect Oct. 1. (Borrowers of existing reverse mortgages are not affected.) Most borrowers will receive about 10% less than they would have before the change. 

We always maintained a reverse mortgage should be a last resort. Before seeking one, consider selling the home (perhaps to someone who will rent it back to you), cash in or sell whole life insurance policies, or tap other assets. While many people want to stay in their homes as long as they can, that is not always the best financial move.

RW December 2009.