Reverse mortgages are complex, difficult to understand home loans and a shift in the way they are being used makes them riskier than ever.
The long awaited “Reverse Mortgages Report To Congress” by the Consumer Financial Protection Bureau (CFPB) paints the same scathing picture previous studies have drawn about the special home loans purportedly designed to help older Americans cash in on their home equity.
The CFPB report says while some risks to consumers have been addressed by federal regulation, but the rules in place need stronger enforcement and more regulation is needed for problematic reverse mortgages
Reverse mortgages are for borrowers 62 or older. The loans, tied to home equity, offer cash payments or lines of credit or a combination of both.
They are called reverse mortgages because no payments are due until the borrower dies, sells the home, leaves the home for 12 consecutive months or more, or fails to maintain the property or pay homeowners insurance or property taxes.
Under those circumstances, the full balance is due. Borrowers also pay a loan origination fee, closing costs, mortgage insurance and compounding interest on the loan principal, all of which can be significant, according to critics.
The National Reverse Mortgage Lenders Association (NRMLA), which announced a new Borrow With Confidence educational campaign in advance of the report to Congress and has long denounced findings in previous studies, was signing a different song after the CFPB study.
“The report raises valid questions and we look forward to a continuing dialogue to collaborate to find answers. All of us want seniors and their children to have a better and more in-depth understanding of reverse mortgages. That is the intent of our Borrow with Confidence consumer education outreach, a comprehensive effort to provide tools that will create the utmost transparency and clear understanding of the reverse mortgage process,” said Peter Bell, NRMLA’s president and CEO.
Luckily, the reverse mortgage market is small. Only about 2 to 3 percent of eligible homeowners currently have a reverse mortgage, and only about 70,000 new reverse mortgages are originated each year.
However, most reverse mortgage borrowers do not use reverse mortgages as intended, to convert home equity into an income stream or a line of credit, according to the CFPB study.
Instead, borrowers take the full reverse mortgage amount in a lump sum and often use the money to refinance an existing mortgage or other debt early in their retirement or even before reaching retirement.
By refinancing with a reverse mortgage, these borrowers eliminate their monthly mortgage payment, but the interest on the loan drains remaining home equity over time. In other cases, borrowers save or invest the lump-sum proceeds, but earn less then they pay on interest.
“Because reverse mortgages can help older homeowners ease the strain of retirement, this product can be beneficial if seniors choose it based on a solid understanding of how it works,” CFPB Director Richard Cordray said.
However, many seniors “struggle greatly to understand this complicated product and the tradeoffs involved.”
Among the findings:
Reverse mortgages are complex products and difficult for consumers to understand.
• Lessons learned from the traditional mortgage market do not always serve consumers well in the reverse mortgage market. The rising balance, falling equity nature of reverse mortgages is particularly difficult for consumers to grasp.
• Recent innovation and policy changes have created more choices for consumers, including options with lower upfront costs. However, these changes have also increased the complexity of the choices and tradeoffs consumers have to make.
• The tools – including federally required disclosures – available to consumers to help them understand prices and risks are insufficient to ensure that consumers are making good tradeoffs and decisions.
Reverse mortgage borrowers are using the loans in different ways than in the past, which increase risks to consumers.
• Reverse mortgage borrowers are taking out loans at younger ages than in the past. In the fiscal year 2011, nearly half of borrowers were under age 70. Taking out a reverse mortgage early in retirement, or even before reaching retirement, increases risks to consumers. 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.
• Reverse mortgage borrowers are withdrawing more of their money upfront than in the past. In fiscal year 2011, 73 percent of borrowers took all or almost all of their available funds upfront at closing. This proportion has increased by 30 percentage points since 2008. Borrowers who withdraw all of their available home equity upfront will have fewer resources to draw upon to pay for everyday and major expenses later in life. Borrowers who take all of their money upfront are also at greater risk of becoming delinquent on taxes and/or insurance and ultimately losing their homes to foreclosure.
• Fixed-rate, lump-sum loans now account for about 70 percent of the market. The availability of this product may encourage some borrowers to take out all of their funds upfront even though they do not have an immediate need for the funds. In addition to having fewer resources to draw upon later in life, these borrowers face other increased risks. Borrowers who save or invest the proceeds may be earning less on the savings than they are paying in interest on the loan, or they may be exposing their savings to risky investment choices. These borrowers also face increased risks of being targeted for fraud or other scams.
• Reverse mortgage borrowers appear to be increasingly using their loans as a method of refinancing traditional mortgages rather than as a way to pay for everyday or major expenses. Some borrowers may simply be prolonging an unsustainable financial situation.
Product features, market dynamics, and industry practices also create risks for consumers.
• A surprisingly large proportion of reverse mortgage borrowers (9.4 percent as of February 2012) are at risk of foreclosure due to nonpayment of taxes and insurance. This proportion is continuing to increase.
• Misleading advertising remains a problem in the industry and increases risks to consumers. This advertising contributes to consumer misperceptions about reverse mortgages, increasing the likelihood of poor consumer decision-making.
• Spouses of reverse mortgage borrowers who are not themselves named as co-borrowers are often unaware that they are at risk of losing their homes. If the borrowing spouse dies or needs to move, the non-borrowing spouse must sell the home or otherwise pay off the reverse mortgage at that time. Other family members (children, grandchildren, etc.) who live with reverse mortgage borrowers are also at risk of needing to find other living arrangements when the borrower dies or needs to move.
• The reverse mortgage market is increasingly dominated by small originators, most of which are not depository institutions. The changing economic and regulatory landscape faced by these small originators creates new risks for consumers.
Counseling, while designed to help consumers understand the risks associated with reverse mortgages, needs improvement in order to be able to meet these challenges.
• Reverse mortgages are inherently complicated, and the new array of product choices makes the counselor’s job much more difficult. Counselors need improved methods to help consumers better understand the complex tradeoffs they face in deciding whether to get a reverse mortgage.
• Funding for housing counseling is under pressure, making access to high-quality counseling more difficult. Some counselors may frequently omit some of the required information or speed through the material.
• Some counseling agencies only receive payment if and when the reverse mortgage is closed (the counseling fee is paid with loan proceeds), which could undermine counselors’ impartiality.
• Some borrowers may not take the counseling sessions seriously. Additional consumer awareness and education may be necessary.
• Counseling may be insufficient to counter the effects of misleading advertising, aggressive sales tactics, or questionable business practices. Stronger regulation, supervision of reverse mortgage companies, and enforcement of existing laws may also be necessary.
Some risks to consumers appear to have been adequately addressed by regulation, but remain a matter for supervision and enforcement, while other risks still require regulatory attention.
• Cross-selling, previously a top consumer protection concern, appears to have been considerably dampened as a result of federal legislation, though some risks remain. Strong supervision and enforcement is necessary to ensure that industry participants abide by existing laws.
• The risk of fraud and other scams is heightened for this population. Vigorous enforcement is necessary to ensure that older homeowners are not defrauded of a lifetime of home equity.
• Special disclosures are required for reverse mortgages, but existing disclosures are quite difficult for consumers to understand.
• There are general prohibitions against deceptive advertising, but there are no specific federal rules governing deceptive advertising with respect to reverse mortgages.