WORD ON THE STREET: For many older Americans, much of their net worth is tied up in their home. Whether they came of age during the Great Depression or are a product of the Baby Boom, these folks have typically worked hard, paid down their mortgages, and perhaps seen their homes increase in value. But, in general, they cannot access that home equity to improve their day-to-day lives without selling the house or taking out a loan.
Homeowners who want to use their home equity to enjoy a more comfortable retirement do have options. One option is a reverse mortgage, a special type of home loan for older homeowners. Economists define a reverse mortgage as a ‘negative-amortization home equity loan.’
What does that mean? Basically, it means seniors can borrow against the equity in their homes, but they do not have to make monthly mortgage payments. Instead of paying down the loan over time, the loan balance actually gets larger, with repayment deferred until the borrower dies, sells the house or moves out of the house.
So, in many ways, this special category of loan acts like a mortgage ‘in reverse,’ with special protections as long as the borrower stays in the home. The loan balance can eventually exceed the value of the home, though the borrower who stays in the home generally does not bear that risk to repay any loan balance beyond the value of the home itself.
So, the reverse mortgage product can provide some peace of mind not afforded by other types of loans. Notably, however, the borrower still remains responsible for paying property taxes and homeowner's insurance, which can cause real problems (including loss of the home) if plans are not in place to continue meeting those obligations each year.
The first reverse mortgage in the U.S. was issued in Maine in 1961. Today, the total market for reverse mortgages remains small, at fewer than 3% of eligible homeowners. But reverse mortgages have the potential to grow rapidly, as 32 million Baby Boomer homeowners become eligible in the coming years.
The Consumer Financial Protection Bureau (CFPB) is releasing the results of a study Congress required on reverse mortgages, and we are requesting more information from consumers about how they are approaching this financial option. 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.
It was anticipated that most people would use their loans to age in place, living in their current homes for the rest of their lives or at least until they needed skilled care. But in some situations, the product can be misused in ways that harm borrowers.
Our study finds, for example, that people are taking out reverse mortgages at a relatively young age compared to their rising life expectancy. The most common age for applicants is 62, which is the first year of eligibility. Much can happen in their remaining lifetimes that could change their intention to remain in the home forever. We also found that more than two out of three people are taking all authorized loan proceeds up front as a lump sum, not as an income stream or a line of credit to enhance their retirement years.
The rise of lump-sum reverse mortgages raises concerns. First, consumers who tap out all their accessible home equity at a relatively young age will have fewer resources available later in life. They may not have the money to continue to pay taxes and insurance, thereby jeopardizing the very home that the reverse mortgage was intended to make secure for the rest of their lives. Alarmingly, our study finds that one out of every 10 reverse mortgages is already in default.
Second, lump-sum reverse mortgages can also prove costly if people ever need to sell their home and move elsewhere. They may be accruing more interest on their loan than they are earning on the money itself, which can become a problem if they later have to repay the loan. Third, taking a large lump sum can pose special dangers, making elderly borrowers into attractive targets for unscrupulous salespeople and scam artists who peddle products unsuitable for their situations.
Our study also found that though many older Americans are aware of reverse mortgages, they struggle greatly to understand this complicated product and the tradeoffs involved. They may focus primarily on the amount of money they can garner in the short term and underestimate the long-term costs. It can be hard to tell whether a reverse mortgage is better than downsizing, refinancing or using a traditional home equity loan. Even when a homeowner makes a careful decision to take out a reverse mortgage, it can be a challenge to select the right product and determine the appropriate amount to borrow initially.
The Federal Housing Administration, which insures the vast majority of reverse mortgages, wisely requires that before taking out a reverse mortgage, consumers must obtain housing counseling from a U.S. Department of Housing and Urban Development-certified counselor. We spoke to a number of housing counselors who have serious concerns about funding, and many acknowledged the challenges they face in educating and assisting people considering reverse mortgages.
People often have misconceptions about how their needs may change as they age in their homes. Some are unaware that a reverse mortgage is a loan, let alone one with negative amortization, as the loan balance rises over time.
In order to protect people against the misuse of reverse mortgages, we need to educate and inform not only older Americans, but also the caretaker generation – people like me with an elderly parent. My father is 94. Those of us in the next generation need to learn about these financial products (and others) to help them make the best decisions possible.
We are working on this through our website, at consumerfinance.gov, with an interactive online tool called ‘Ask CFPB.’ It contains easy-to-understand answers to frequently asked questions about various financial products, including reverse mortgages. Older Americans and those who love and care for them can review this information to consider whether or not a reverse mortgage is the right financial choice for them.
Efforts like ‘Ask CFPB’ cannot succeed in making the costs and risks of reverse mortgages clear if lies and deception are infecting the market. Consumers tell us stories about being deceived and misled. Just recently, we saw a mailer that portrayed a reverse mortgage as a government benefit rather than a financial product. The mailer came with what appeared to be a government seal and claimed that a phony piece of legislation would help seniors save their homes. All the senior had to do was call a supposed ‘senior helpline’ in order to receive the so-called government benefit. The mailer also contained blatantly false information about loan repayment options.
Practices like these cannot be allowed to continue. We will work with our partners at the federal, state and local levels to root out these kinds of scams. We are currently receiving reverse mortgage complaints through the Web and our hotline. We will use our supervisory and enforcement authority, as appropriate, to monitor the markets and take action against unfair, deceptive, or abusive practices.
We also have the authority to develop specific protections and disclosures for reverse mortgage borrowers. The Federal Reserve Board had begun to consider a rulemaking when that authority shifted over to us. We will consider measures to ensure that the reverse mortgage market is working well for consumers and responsible lenders.
Richard Cordray is the director of the Consumer Financial Protection Bureau. This article is adapted and edited from prepared remarks delivered June 27. The original text is online.