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Reforms Come to Reverse Mortgages
W hen Karen Hunziker’s husband, Charles, died a month after having a stroke in May 2014, she was devastated. Ten days later, she got another shock: a letter from a loan servicing company saying she’d have to pay off the reverse mortgage on her home or it would go into foreclosure.
The Hunzikers had taken out a reverse mortgage in 2008. Karen, an artist, and Charles, who worked at a local warehouse, wanted to borrow $20,000 to do repairs on their home in Pollock Pines, Calif. The loan allows older homeowners to borrow against the equity in their home. As long as you keep up with your property taxes, home insurance, and house maintenance, a reverse mortgage doesn’t have to be paid back until you move out, sell your home, or die.
At the time, Karen was 60, two years too young to qualify for that type of loan. So she agreed to be removed from the title so that Charles, then 65, was the sole borrower.
Karen says the lender repeatedly assured her that she’d be able to stay in the home if anything happened to Charles. But when she contacted the loan servicer after Charles died, she was told that her home was scheduled for auction in 30 days.
“I barely had a chance to mourn, and I was told I would have to get out of my house,” says Hunziker, now 68.
Karen’s experience is the kind of horror story that has long led some consumer advocates and financial planners to consider reverse mortgages too risky, a loan of last resort. In addition to problems when a surviving spouse isn’t on the loan, these compounding-interest loans can be expensive. And seniors who can’t keep up with taxes, insurance, and home upkeep risk defaulting on the loan and losing their house.
But over the past three years, new government regulations aimed at protecting older borrowers and shoring up the government-backed loan program have gone into effect.
To be sure, the loans remain a poor choice for some, and at Consumer Reports we believe more reforms are needed. But some experts say that for certain homeowners, with the new regulations in place, it may make sense to consider a reverse mortgage.
One high-profile proponent is Massachusetts Institute of Technology professor Robert Merton, a Nobel Prize-winning economist who has studied reverse mortgages for more than a decade. It’s an unfortunate reality, he says, that many people haven’t saved enough for retirement. At the same time, a fast-growing number of the 76 million baby boomers, now 52 to 70 years old, are moving into the eligible age range for reverse mortgages, making them a prime audience for the loans.
Among Americans 55 to 64, 55 percent report little to no retirement savings, according to a May 2015 Government Accountability Office report. But 74 percent of people 55 and older own their homes. Merton has come to see that “home equity could be a solution” for retirees who would like to improve their standard of living. “Will we still have problems with reverse mortgages? Of course we will,” Merton says. “Do we need improved design, lower closing costs, and better regulation? Yes. But a well-functioning reverse mortgage is going to be key for working- and middle-class people to have a good retirement.”
If you’re considering a reverse mortgage, it’s critical to know what you are getting into, given the loans’ complexity, cost, and controversial nature. Here’s what you need to know:
A Troubled History
Though never a big part of the mortgage market, government insured reverse mortgages—formally known as Home Equity Conversion Mortgages (HECMs)—have been around since 1987. Congress created them with the aim of helping cash-strapped homeowners 62 and older pay for critical everyday living expenses by drawing income from their home, usually their biggest asset.
The loans took off along with the housing boom that boosted home values in the 2000s. Lenders gave retirees incentives to take all of the money out up front. Some were talked into using the money for ill-advised investments or spent it on noncritical home improvements. About 40 percent say the primary reason they used the loan was for extra income to pay for daily living expenses, according to Stephanie Moulton, an associate professor at Ohio State University who did a study of seniors who took reverse mortgages between 2006 and 2011.
But after the real estate bust deflated home values and the Great Recession hit, homeowners in shaky financial positions began falling behind on property tax and home insurance payments. Defaults rose by half, from 8 percent in 2010 to 12 percent in 2014.
“There was no requirement to check to see if a borrower could really afford to stay in their homes,” Moulton says. “Reverse mortgages were supposed to give seniors more financial security, but for some seniors, that wasn’t happening.”
Meanwhile, the barrage of reverse mortgage ads on radio and TV has continued unabated. The ads, featuring B-list actors such as Henry “The Fonz” Winkler (shown below), aggressively pitch reverse mortgages to seniors as a risk-free way to supplement retirement income.
Those ads can be misleading, the Consumer Financial Protection Bureau says. It issued a report last June saying that many reverse mortgage ads are inaccurate or omit important information.
The CFPB also studied complaints made about reverse mortgages from 2011 to 2014. It found that many consumers were confused about how the loans worked or got the runaround from loan servicers when there were problems.
“We don’t see reverse mortgages as innately bad. For the right consumer at the right time, these loans may be an excellent choice,” says Stacy Canan, deputy assistant director at the CFPB’s Office of Financial Protection for Older Americans. “But this is a complicated mortgage product and one we see that consumers don’t often understand,” Canan says.
Tougher New Rules
It’s not just homeowners who can get into trouble with reverse mortgages. The Department of Housing and Urban Development insures HECMs and is on the hook if a foreclosed home sells for less than the loan’s value. It must reimburse the lender for the difference. The rules it rolled out starting in 2013 and continuing through last year were instituted not just to weed out selling to borrowers unsuited to the loans but also to reduce its own risk insuring them. The new rules include:
Tighter borrowing limits. Starting in 2014, most borrowers can take only 60 percent of the loan in the first year. Some may be eligible to take out more but must pay higher up-front costs.
Stricter financial requirements. In the past almost anyone with sizeable home equity could qualify for a reverse mortgage. Since April 2015, lenders are required to assess the borrower’s income, cash flow, and credit history to make sure they have enough to pay the future costs of owning the home. If they don’t, they may still qualify if they can put aside money from the loan to cover future taxes, insurance, and maintenance costs. If not, they won’t get the loan.
Stronger spousal protections. As Karen Hunziker found out, if a spouse isn’t listed as a borrower and the borrowing spouse dies or moves out (say, to a nursing home) for more than 12 months, the loan has to be repaid immediately or the surviving spouse faces foreclosure. Last June, HUD adopted a policy that allows a nonborrowing spouse to remain in the home as long as it is their primary residence and taxes and insurance are paid.
If those financial checks and loan limits had been in place sooner, a recent study by Moulton estimates, defaults would have been about 40 to 50 percent lower.
Still, some consumer protection experts say the reforms haven’t gone far enough and that loan servicers are dragging their feet helping surviving spouses take advantage of the new rules that allow them to remain in their home. A recent National Consumer Law Center survey of elder advocates found that their clients were experiencing that. “We welcome these reforms—they give consumers more options,” says Odette Williamson of the NCLC. “But there is more work to be done on behalf of consumers to make sure that the options are truly available to them without jumping through a lot of hoops.” Norma Garcia, a senior attorney for Consumer Reports, adds that aggressive marketing, loan complexity, and borrower confusion also remain troubling concerns.
One important change Consumer Reports advocates is a requirement for seniors to fill out a detailed questionnaire walking them through the loan’s possible consequences before filling out a mortgage application. The worksheet, which we helped design with a neurology professor who studies decision-making in older adults, is mandatory in California. Consumer Reports would like it to become a national policy. That would be in addition to required counseling usually done by phone. “This is a much more effective tool that actively engages people in decision-making and aids counseling,” Garcia says. To see the worksheet, go to canhr.org and click on Free Consumer Fact Sheets, then sheet No. 52.
A Strategic Approach
Some academics and financial planners say that reverse mortgages, strengthened by the reforms, can be used strategically by people who are worried about running out of money in retirement.
For example, rather than take a reverse mortgage as a lump sum, you can access the equity in your home as a monthly payment, says Steven Sass of Boston College’s Center for Retirement Research, where he is director of the Financial Security Project.
A lump sum is tempting to spend quickly, whereas a monthly payment gives you a regular stream of income that draws down your equity more slowly, he says. Sass recommends first investigating other, less expensive options, such as downsizing your house (see below). But with the stringent financial checks and borrowing limits, reverse mortgages “are safer products,” he says.
Alternatively, you could set up a reverse mortgage as a standby line of credit, says John Salter, a certified financial planner and professor of personal financial planning at Texas Tech University in Lubbock. That way the money is available if you have big unexpected expenses, such as a health emergency. “It’s there if you need it, and if you don’t, you never need to tap it,” he says.
Also, Salter suggests that if the financial markets are down, you could take income from a reverse mortgage line of credit rather than from other investments. Once those investments recover, you can repay the loan. You could also put off taking Social Security longer by using a reverse mortgage to supplement income early in retirement. Delaying Social Security allows the benefit payment to grow, which would give you a higher lifetime guaranteed income stream that is adjusted for inflation. As with any transaction involving your home’s equity, you should discuss the implications with an independent financial adviser.
Having money in reserve is what appealed to Ralph Kumano, 71, who took a reverse mortgage on his two-bedroom home in Auberry, Calif., earlier this year. A retired biology teacher, Kumano has no debt, and his home, appraised at $166,000, is paid off. He qualified for an $87,000 loan and set it up as a line of credit. “It’s mainly for emergencies,” he says. Having those funds available also means that if he needs cash, he doesn’t have to take more than the minimum he is required to take from his retirement accounts, which increases his taxable income. “The money from my house is tax-free,” Kumano says.
As for Karen Hunziker, the new regulations appear to have come just in time. The protections for nonborrowing spouses were extended to loans made before Aug. 4, 2014. With the help of Sandy Jolley, an independent reverse mortgage consumer advocate, Hunziker was able to stall the foreclosure until the new spousal guidelines were in place. “The new law was a lifesaver in Karen’s situation,” Jolley says. “She would have lost her home if it weren’t for this change.”
How to Decide If a Reverse Mortgage Is Right for You
How Long Do You Plan to Stay in Your House?
As with a traditional home loan, taking out a reverse mortgage costs thousands of dollars in closing costs and fees. But reverse mortgages come with an additional expense: Borrowers pay 0.5 percent of the loan amount up front and 1.25 percent annually for government mortgage insurance. If you leave your home soon after taking the loan, you’ll lose a big chunk of your home equity to fees for only a small benefit.
Is There Another Way to Meet Your Money Needs?
If you’re really strapped for cash, consider downsizing to lower your expenses. According to the Center for Retirement Research, the cost of taxes, insurance, maintenance, and utilities average about 3.25 percent of the home’s value each year. Downsize from a $250,000 home to a $150,000 one and you’ll cut annual expenses about $3,250, from $8,125 to $4,875.
Will Your Home Suit You as You Age?
Reverse mortgages make the most sense if you plan to stay in your home a long time. So consider whether you can continue living there independently in your later years. Think about things such as: Does it have a lot of stairs you may have trouble getting up and down? Is it far from hospitals, doctors, or family members who can look out for you?
Can You Live There If Something Happens to Your Spouse?
If you’re married and your spouse dies or goes to a nursing home and can no longer contribute income or help with home maintenance, make sure you can afford to live in the home. Interest on the loan compounds, so also consider whether you will have enough equity left to finance long-term-care costs if you need to go to a nursing home.
Editor's Note: This article also appeared in the May 2016 issue of Consumer Reports magazine.
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