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March 24, 2003
�I read a lot about
reverse mortgages and how they are becoming part of the financial mainstream.
Is this true, and if so, why?�
Reverse
mortgages are picking up some steam, but they have a long way to go.
A
reverse mortgage is a loan to an elderly homeowner on which the borrower�s
debt rises over time, but which need not be repaid until the borrower dies,
sells the house, or moves out permanently.
The
�forward� mortgages that are used to purchase homes build equity �
the value of the home less the mortgage balance.
Borrowers pay down the balance over time, and by age 62, when they become
eligible for a reverse mortgage, loan balances are either paid off or much
reduced.
Reverse
mortgages, in contrast, consume equity because loan balances rise
over time. If there is a balance remaining on a forward mortgage at the
time a reverse mortgage is taken out, it is paid off with an advance under the
reverse mortgage.
The
need for reverse mortgages has always been there.
It is plausible to build equity during high-earning years, and consume it
after retirement. It is even more
plausible when other sources of retirement income aren�t enough to permit
homeowners to maintain their lifestyle. It
is most plausible when there isn�t enough income to even maintain their house
and pay the taxes. Without reverse
mortgages, the only way to consume equity is to sell the house and live
elsewhere.
Yet
reverse mortgages have always been a hard sell.
In the 1970s and early 80s, I was personally involved in developing two
reverse mortgage programs that offered excellent products.
Neither program survived.
The
major problem was not a lack of interest. Elderly
homeowners with a need for extra money and no inclination to leave their houses
to heirs invariably showed great interest.
The problem was a lack of follow-through that resulted in transactions.
The
decision was one on which it was very easy to procrastinate.
Unlike taking a forward mortgage 30 to 40 years earlier, when the family
needed a house to live in, there was no comparable pressure to execute a reverse
mortgage. They had the house and
the children were long gone, so a decision could be deferred indefinitely.
This
tendency was strengthened by the fact that the decision involved their largest
asset by far, which had emotional value beyond its financial value.
Further, they were at a stage of life where they might not be able to
recover from a serious mistake.
Caution
and concern were heightened by stories about people like themselves who took out
reverse mortgages and were later forced out of their homes.
Several depository institutions offered deals to seniors that provided
monthly loan advances over a set period, but did not guarantee lifetime
occupancy. The deal was that the
senior could remain in the house only so long as its value exceeded the
accumulated debt. Since the debt
tended to grow faster than the property value, eventually, if they lived long
enough, they would be forced out of their homes.
The
landscape began to change in 1988 with the development of a Federal program
under the FHA called the Home Equity Conversion Mortgage (HECM).
The borrower protections built into this program, along with the
imprimatur of the Federal Government, paved the way toward increasing acceptance
by elderly homeowners. The AARP
also entered the picture as a major information source (see www.aarp.org/revmort).
HECMs
account for about 95% of all reverse mortgages being written today.
Other reverse mortgage programs are available from Fannie Mae, and from Financial
Freedom Senior Funding Corporation, a subsidiary of Lehman Brothers Bank, FSB.
In addition, some limited special purpose programs are available from
some states and cities.
Under
all the programs cited in the paragraph above, borrowers have the right to live
in their house until they sell it, die, or move out permanently, regardless of
how much their mortgage debt grows. If
the debt comes to exceed the value of the property, the FHA or the lender takes
the loss. In addition, loans under
these programs are without recourse. This
means that lenders cannot attach other assets of borrowers or their heirs in the
event that the reverse mortgage debt comes to exceed the property value.
Reverse
mortgage activity today is at an all-time high.
The number of new HECMs jumped from 7,781 in 2001 to 13,048 in 2002.
Still, this is a drop in the bucket when compared to the size of the
potential market. Increasing
numbers of seniors are realizing they can take reverse mortgages safely, but
most still haven�t gotten the message. The
mainstream stills lies ahead.
Copyright
Jack Guttentag 2003
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