Reverse mortgages a tool best used with caution

When my grandmother retired after working 25 years as a nursing assistant, she was mortgage-free. It was the achievement of a lifelong goal to reach a certain level of financial independence.

However, what happens if you’ve paid off your mortgage but find that you’re house rich and cash poor?

Many seniors are finding they are cash poor because of poor money management or by no fault of their own. Job losses, unreimbursed medical expenses or both have wiped out their savings.

Recognizing that many older Americans were free of a mortgage but also cash-strapped, decades ago a savings and loan came up with an appealing loan product — the reverse mortgage — that allows people who are 62 or older to borrow against their home’s equity.

Unlike a traditional home loan, no payment is due on a reverse mortgage until you move, sell or die. If your home is sold, any equity that remains after the loan is repaid is distributed to you or your estate. Typically, a reverse mortgage works best if you plan to stay in your home for a long time. The longer you stay, the less expensive the loan is because the upfront fees are so high.

Borrowers can take the loan as a line of credit, a lump-sum payment, fixed monthly payments or a combination. The loan size depends on the borrower’s age and other factors.

For many seniors, a reverse mortgage can be a saving grace. But this product isn’t without issues, according to a newly released report from the Consumer Financial Protection Bureau, which was required to study reverse mortgages as part of the Dodd-Frank financial reform act.

For most Americans, their home is their largest asset. In 2009, half of homeowners 62 and older had at least 55 percent of their net worth tied up in home equity. In looking at the reverse mortgage market, the consumer bureau notes that only about 2 percent to 3 percent of eligible homeowners currently have a reverse mortgage and just 70,000 new reverse mortgages are originated each year.

“But reverse mortgages have the potential to become a much more prominent part of the financial landscape in the coming decades,” the bureau said in its report.

The bureau found some troubling issues. For instance, even though borrowers have to get mandatory pre-loan counseling, many still don’t understand the intricacies of a reverse mortgage.

I’ve talked to a number of seniors who have gone through the whole process, and their lack of understanding of the product was worrisome. Further, some counseling agencies only receive payment when the reverse mortgage is closed, which could undermine counselors’ impartiality, the bureau points out.

Yet another concern: People are taking out loans at younger ages. Last year, nearly half of borrowers were under 70. And when seniors are opting for a reverse mortgage, they are taking out more money than in past years. Seventy-three percent of borrowers took all or almost all of the available equity upfront at closing in 2011, an increase of 30 percentage points since 2008.

“Taking out a reverse mortgage early in retirement, or even before reaching retirement, increases risks to consumers,” the bureau said. “By tapping their home equity early, these borrowers may find themselves without the financial resources to finance a future move, whether due to health or other reasons.”

The bureau found that a large proportion of borrowers (9.4 percent as of February 2012) are at risk of foreclosure because they haven’t paid their property taxes and insurance. The pool of people in this position is growing.

“With 1 in 10 reverse mortgages already in default, it is important that consumers understand what they are signing up for and that it is the right product for them,” said CFPB Director Richard Cordray.

The agency has the authority to impose regulations on reverse mortgages. It is asking for public comment before deciding whether other measures are necessary. If you want to weigh in on this issue, go to www.consumerfinance.gov. On the home page click on the link for “Regulation” and then click on “Notice and comment.” Under that heading you will find information on how to share your views or experiences with reverse mortgages. The bureau has also developed a short consumer guide with key information on reverse mortgages.

A reverse mortgage isn’t a bad product. But consumer groups have long complained about deceptive or misleading marketing practices. The bureau’s report raised enough red flags to warrant the agency taking whatever steps necessary to protect people considering this financial option.

Michelle Singletary: singletarym@washpost.com.

Washington Post Writers Group

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