Ever since Nelson Haynes of Deering Savings & Loan originated the world’s first reverse mortgage loan in 1961 to a Portland, Maine widow reverse mortgages have grown steadily in popularity. Counting only FHA-insured reverse mortgage loans, originations have grown from just a few hundred in 1990 to more than 110,000 in 2008. Whereas for some seniors getting a reverse mortgage is a way of preserving a certain standard of living and buffering against a dwindling income, for many unfortunate others it’s the financial equivalent of a life raft, a last resort for affording basic necessities like prescription medications and other expenses. Be it a buffer or life raft, a reverse mortgage offers a way of tapping into the often overlooked nest egg of home equity.
So what is a reverse mortgage and how does this strange, almost counterintuitive type of loan work? Also known as a Home Equity Conversion Mortgage (H.E.C.M.) a reverse mortgage is a loan that allows a borrower at least 62 years of age to convert a portion of the equity built up in his or her home into a stream of income. No repayment of the loan is required so long as the borrower continues to occupy the property as his or her principle residence. Reverse mortgages are offered under FHA, Fannie Mae, Freddie Mac, some ‘ALT-A’ lenders, as well as some local and state governments. While differences exist among these programs with respect to basic eligibility requirements, loan terms, cost, etc., all reverse mortgages work in the same basic way.
One way of understanding a reverse mortgage is in terms of its exact opposite, the forward mortgage, also known as a conventional home mortgage. In this context, the term “forward” refers to the direction of the payment stream. With a conventional mortgage the stream moves in a forward direction, i.e., from the borrower to the lender. As the borrower makes payments over time the amount owed gets smaller. With a reverse mortgage, this payment stream is reversed. Now the lender makes payments to the borrower and over time the amount owed on the property gets larger. While the borrower maintains ownership and holds title to the home, the amount owed on the property is due and payable only when he or she moves out of the home or otherwise fails to reside at the property as his or her primary residence.
There are basic eligibility requirements that apply to both the borrower and the property. A borrower must be at least 62 year of age or older, with no maximum age. Although credit is generally not a factor when qualifying, a reverse mortgage applicant who is in default on any debt owed to a federal agency must satisfy the debt, bring the loan balance current or have a documented payment arrangement in place with the federal agency. Most programs are similar in this regard. The home to be financed must be owed free and clear or have a small loan balance that can be paid out of the proceeds of the new loan. The lender must offer information on reverse mortgage counseling services and the borrower must receive counseling from an independent, reverse mortgage counselor prior to applying for the loan. The property must be a 1-4 family residence. Some condos, manufactured homes, and Planned Unit Developments may also be eligible. Having met the basic eligibility requirements, the borrower may now seek and obtain a reverse mortgage.
How much a person can borrower depends on variables such as the age of the youngest borrower, the amount owed on the property, the appraised value and the cost of the proposed loan. There are four options for receiving payments from the lender:
1. Lump sum – borrower receives all of the cash at once.
2. Cash advance – borrower receives regular monthly payment.
3. Line of credit – borrower has flexibility as to how much cash is received.
4. Combination – borrower may choose a combination of all three options.
Once frowned upon by many financial advisors, funds received from a reverse mortgage have gradually gained acceptance as an efficient source of tax-free income. But negative perceptions still exist, and in many cases, for good reason. As the number of reverse mortgage loan originations has grown, so has the number of attempts to defraud unsuspecting seniors.
As the saying goes, “Where there’s a will there’s a scam.” This is especially true for transactions involving large sums of money. So naturally scammers are drawn to the mortgage industry in general and the reverse mortgage industry in particular since this is where all the equity is. Here are a few examples of reverse mortgage scams perpetrated by unscrupulous loan officers:
- Reverse mortgages are bundled with other products like living trusts, home improvements and even burial plots. The loan officer leads the borrower to believe that he or she must buy one of these products to be eligible for a reverse mortgage.
- The loan officer downplays the requirement that makes it mandatory for applicants to receive counseling free of charge from an independent HECM counselor. While HUD allows for telephone-based counseling in cases where it is simply too much of a burden on borrowers to travel and meet in-person, face-to-face counseling is strongly encouraged. Scammers try to capitalize on this allowance by steering applicants to cohorts offering counseling services, often for a fee, that are watered down at best or filled with disinformation at worst. The result is that many ill-informed borrowers unwittingly relinquish obscene amounts of equity to these unscrupulous operators.
- Forgery is used to steal a portion of the loan proceeds. With this scam, the loan officer convinces the escrow agent to cut two separate checks. One is delivered to the borrower while the other endorsed by the loan officer using a forged signature and then deposited.
While these aforementioned dangers are a cause for legitimate concern, there are other dangers that derive from perceptions that often have no basis in reality. Some typical concerns among seniors contemplating a reverse mortgage have to do with their own longevity versus the life of the loan. Many seniors believe they might somehow lose their homes. In fact, as a borrower continues to live in the home as a principle residence the home cannot be lost. And there is no possibility of losing the home should the borrower outlive the mortgage loan. Also, inheritance of the property is affected only by the amount owed on the property and not by the fact that there is a lien against it. When a borrower passes away, the total amount of funds received plus interest and any fees gets subtracted from the remaining equity in the home. This remainder is available to the borrower’s heirs.
In conclusion, the reverse mortgage industry has grown beyond what anyone ever foresaw. Changing economic times, an aging population and increased health care costs have all contributed to the growing popularity of this type of loan. While there are very real dangers associated with the reverse mortgage loan process, the same is true for almost anything in life. It’s just that there’s more on the line when a person’s ability to survive and live the remainder of his or her life with a modicum of dignity is at stake. But well designed regulation and sufficient oversight can work to ameliorate many of these problems. And prudence in the form of due diligence and proper counseling is a borrower’s best defense against dangers seen and unseen.