By Mark Miller
CHICAGO, July 6 (Reuters) - Consumer advocates, government regulators and watchdogs have been warning seniors for several years about the risks associated with reverse mortgages. Now, the red flags are being hoisted significantly higher.
The new federal Consumer Financial Protection Bureau (CFPB) has issued a report signaling a likely tightening of regulations for reverse loans. Regulation of all mortgages was transferred to the CFPB under the Dodd-Frank reform law. Congress also instructed the agency to produce a detailed study on the reverse loan market - and to issue new regulations if its research uncovered unfair, deceptive or abusive practices.
The CFPB’s report confirms earlier warnings that reverse mortgages have become an increasingly risky business for borrowers and would-be borrowers. A growing number of borrowers are taking on reverse mortgage loans at younger ages in return for large lump payouts that carry high fixed rates of interest. And a growing percentage of outstanding loans are at risk of default.
While it is clear CFPB will be considering new regulations, the agency, and the industry, are taking steps to educate consumers on how to avoid problems with reverse loans.
“We’re going to continue to follow this, and work to get answers to our questions,” says Hubert H. (“Skip”) Humphrey III, who heads up CFPB’s Office of Older Americans.
Reverse mortgages, available to homeowners over age 62, allow seniors to turn equity in their home into cash while staying in their homes. Unlike a forward mortgage, where you use income to pay down principal and increase equity, a reverse mortgage pays out the equity in your home as cash; your debt level rises and equity decreases.
The most popular loan type is the Home Equity Conversion Mortgage (HECM), which is administered and regulated by the U.S. Department of Housing and Urban Development, and insured by the Federal Housing Administration.
Repayment typically is triggered when a homeowner dies or moves out permanently, and is typically funded through sale of the home. If the balance on a HECM is higher than the value of the home, the FHA makes up the difference.
While reverse mortgages offer seniors in need a useful way to tap home equity, the CFPB found that reverse loans are too complex for most seniors to understand. Many struggle to understand the rising balance/falling equity structure of the loans, or do not understand that reverse mortgages really are loans.
”Many aspects of a reverse mortgage do seem counterintuitive, says Peter Bell, president of the National Reverse Mortgage Lenders Association. “They are not fully understood. The NRMLA recently launched its own consumer education campaign () and the CFPB has published a free brochure that offers consumers a basic checklist of issues to consider ().”
Another problem is the plunging age of borrowers. Nearly half of borrowers in 2011 were under age 70, with many using proceeds to pay off traditional mortgages rather than to meet current expenses. That can leave borrowers without options if later financial problems exhaust their other assets.
Moreover, 70 percent of borrowers are taking large lump sum payments at fixed interest rates rather than more flexible lines of credit at adjustable rates. In the traditional forward mortgage market, adjustable rate loans often are perceived as the more risky choice, but the opposite often is true with reverse mortgages.
Fixed-rate loans pay an upfront lump sum of the full mortgage amount, which means they rack up much higher interest costs and deplete borrowers’ equity far more rapidly.
HUD data shows that 9.4 percent of outstanding reverse loans are in danger of default for failure to pay taxes and insurance, a figure that is on the rise.
”The lump sum loan leaves you with no flexibility or cushion,“ says Megan Thibos, a policy analyst in CFPB’s mortgage markets group and principal author of the report. ”If you take an adjustable rate line of credit and fail to pay your taxes or insurance, the lender can process a payment from your line of credit. “But that’s not possible if you’ve taken it all upfront,” she says.
The report raises questions that could set the stage for new regulations of the industry by the agency. But in the meantime, here are key takeaways for any older American considering a reverse loan:
“Be sure you really understand what you’re getting into before signing any papers,” says Thibos, who urges seniors to be especially cautious about any loan that changes the title to the home.
Seniors sometimes choose to remove one spouse from the property’s title to get a reverse loan, particularly if only one spouse has reached the qualifying age of 62. In other cases, it allows an older spouse to qualify for a higher loan amount, since loan amounts are tied to the borrower’s age.
“That’s very risky,” Thibos says. “If the older spouse passes away or vacates the property to enter a nursing home, the younger spouse can lose the home.”
“Don’t believe everything you hear,” adds Norma Garcia, senior attorney at Consumers Union. “Talk with an elder-law attorney, a financial planner or an accountant.”
Seniors must undergo counseling from HUD-approved advisers before loans can be issued, but many do not take it seriously. “Many seniors see counseling as a speed bump on the way to a goal, rather than a chance to really learn about what they are getting into,” Thibos says. “We want to urge seniors to take it seriously.”
Many younger borrowers are using reverse loans to retire an existing forward mortgage. While getting rid of a mortgage payment is appealing, it is a step that consumes most of the equity you’ve built up in your home, and leaves you with accruing interest and fees. Options to consider include downsizing to a less expensive home, or working longer.
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