Study: Consumers taking out reverse mortgages earlier

Much of the wealth of millions of baby boomers is tied up in their houses — a sure sign we’re going to see a growing demand for reverse mortgages.

These mortgages allow older homeowners to drain the equity in their house without having to sell it or make monthly payments.

For now, though, these complex loans make up only a tiny percentage of housing loans — and that’s a good thing. It gives regulators, the industry and consumer advocates time to bolster borrower protections and education before widespread problems occur.

And there are problems.

A new report by the Consumer Financial Protection Bureau found that these loans are so different from traditional mortgages that many consumers have trouble grasping how they work. Product changes in recent years and greater choices have only added to consumers’ confusion, the bureau says. And mandatory counseling for prospective borrowers often isn’t enough to combat misleading mortgage advertisements.

Perhaps more troubling: Borrowers increasingly are taking out these loans at the earliest possible age and in a lump sum. This raises the risk that they could blow through the money early on and won’t have it later in life if they fall into dire financial straits.

Besides issuing the report, the consumer bureau also can write regulations on reverse mortgages. It is accepting public comment on these loans until late August.

Reverse mortgages traditionally have been considered a loan of last resort for cash-strapped seniors who have exhausted other resources but want to remain in their homes.

“A reverse mortgage isn’t for everyone,” says Tom Simonton, housing counselor manager with the Consumer Credit Counseling Service of Maryland and Delaware. But, he adds, the loans can be “a fantastic financial tool.”

Homeowners must be at least 62 to qualify. The amount they can borrow depends on their age, the amount of equity in the house and the interest rate on the loan.

They can take the money as a lump sum, a line of credit, a monthly income stream or a combination of these payments.

Borrowers don’t make monthly repayments as with a traditional mortgage. Instead, the loan balance, which includes interest, accumulates over time. When the borrower dies or moves, the house is sold and the proceeds are used to pay off the balance.

Homeowners must undergo housing counseling before they take out a federally insured reverse mortgage so they know what they’re getting into.

But the Consumer Financial Protection Bureau’s recent report, ordered by Congress, makes you wonder if all borrowersunderstand the risks of these loans. Among the bureau’s findings:

•The most common age of new borrowers is 62. Draining equity so early means these borrowers might not have the money if they encounter financial hardship later.

•Borrowers are choosing to take the money as a lump sum about 70 percent of the time. The concern is that homeowners in later years might not have enough cash left to keep up with property taxes and homeowners’ insurance. In February, nearly one in 10 reverse mortgage borrowers was at risk of foreclosure for failing to pay taxes and insurance.

•Borrowers who invest the mortgage money could pay more for the loan than they earn on their investments.

•Spouses who aren’t co-borrowers on the loan often do not realize they are at risk of losing their home if their mate dies.

•Misleading advertising persists, with marketers wrongly claiming that the mortgages are a government benefit and that borrowers can never lose their home.

•Funding for counseling is being cut, and some counselors are paid with the loan proceeds only after a consumer takes out a mortgage. That creates an incentive for counselors to nudge homeowners to borrow.

It is unclear why homeowners are taking out reverse mortgages at much younger ages.

In 1990, the average age of a reverse mortgage borrower was nearly 77, says Norma Garcia, a senior attorney with Consumers Union who has studied reverse mortgages for years.

Some loan experts say workers are being forced into early retirement and that this might be the only way to make ends meet.

The high percentage of borrowers opting for a lump sum also is troubling, especially considering that they could end up paying more in interest over the life of the loan.

“People don’t appreciate the risks involved” with a lump sum, Garcia says. “Once those funds are gone, there aren’t any more.”

Many prospective borrowers come into counseling after talking to a lender and are determined to take a lump sum, says Simonton, of the credit counseling agency.

However, Simonton says, some people change their minds after learning all the options. For instance, they could be much better off taking their money in a line of credit that they can tap when they need cash, he says. They won’t pay interest until they withdraw money. And if they aren’t using the line of credit, the lender pays them interest.

Simonton says counseling sessions take at least two hours, and his agency follows up with borrowers six months later.

“Most are happy; some people are not,” he says. “They chose to take the lump sum and the money is gone.”

But the first question isn’t whether to take a lump sum, but whether homeowners have better options than a reverse mortgage.

Reverse mortgages have lowered their fees in recent years, but the loans still aren’t cheap. Home equity lines of credit and other types of borrowing are often less costly if homeowners qualify.

Other options include selling your house and moving into a smaller, more affordable place.

Some elderly homeowners take out reverse mortgages so they can add ramps or other features to allow them to remain in the house. Garcia says these seniors should first check with local agencies that can tell them about programs that provide financial assistance for such projects.

Garcia says adult children can create a reverse mortgage on their own to help an elderly parent. The family draws up a contract in which the children agree to pay $100 or $200 a month to the parent. When the parent dies, she says, the house is sold and the children recoup their money from the proceeds.

“Consider a reverse mortgage only as your last option,” Garcia says. “It can be a very expensive way to meet your needs.”