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Reverse mortgages are a really, really bad idea

I have made mistakes in my life that made me want to go back in time and undo them. Sometimes you can, but sometimes you can’t go back and reverse the damage. Taking on a reverse mortgage is one mistake that is very difficult to undo. I don’t like reverse mortgages. I don’t like many forms of debt, but reverse mortgages are one of the worst forms out there.

According to the Department of Housing and Urban Development:

A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash. The equity that built up over years of home mortgage payments can be paid to you. But unlike a traditional home equity loan or second mortgage, no repayment is required until the borrower(s) no longer use the home as their principal residence or fail to meet the obligations of the mortgage.

If you don’t have to make any payments, it shouldn’t be too difficult to meet the obligations of the mortgage. Also from the HUD website:

What’s the difference between a reverse mortgage and a bank home equity loan?

With a traditional second mortgage, or a home equity line of credit, you must have sufficient income versus debt ratio to qualify for the loan, and you are required to make monthly mortgage payments. The reverse mortgage is different in that it pays you, and is available regardless of your current income. The amount you can borrow depends on your age, the current interest rate, and the appraised value of your home, sales price or FHA’s mortgage limits, whichever is less. Generally, the more valuable your home is, the older you are, the lower the interest, the more you may borrow.

Reverse mortgages provide seniors with plenty of equity and limited income the ability to tap their equity to meet the needs of daily life. Basically, they didn’t want grandmothers to eat dog food if they had a lifetime of filet mignon tied up in home equity. Selling the family home is sacrosanct, so the government developed a program to allow seniors to tap their home equity. As you might imagine, loaning seniors money when they have no ability to repay has potential for abuse and predatory lending. Fortunately, the market is heavily regulated by HUD.

Reverse Mortgages Worry Regulator

Updated June 27, 2012, 6:55 p.m. ET — By MAYA JACKSON RANDALL

WASHINGTON—A U.S. financial regulator warned that new rules may be needed to address hidden dangers in reverse mortgages, the special loans that enable cash-strapped seniors to borrow against the equity in their homes.

Deceptive marketing practices, complicated loan terms and misleading marketing materials are some of the problems the Consumer Financial Protection Bureau highlighted in the $90 billion industry, which is expected to grow in popularity as tens of millions of baby-boomer homeowners grow older and struggle to pay for retirement.

Any new regulations would affect industry leaders such as Quicken Loans and Wall Street financial firms like Guggenheim Partners and Knight Capital Group Inc., which own companies that make reverse mortgages. Large banks such as Bank of America Corp. and Wells Fargo & Co. have left the market amid rising defaults and declining home prices.

Nearly 10% of reverse-mortgage borrowers are at risk of foreclosure because they have failed to pay taxes and insurance, according to the CFPB’s study, mandated by the 2010 Dodd-Frank financial overhaul.

With falling house prices, many reverse mortgage holders found themselves underwater and unable to tap the housing ATM through reverse mortgages. Since they had no real financial interest in the property, many seniors see no need to pay the taxes and insurance. In their minds, it’s the bank’s problem, and when on a fixed income, house taxes and insurance are a major financial expense.

Reverse mortgages, targeted at homeowners over 61 years old, are similar to home-equity lines of credit. But instead of a monthly payment, repayment is deferred until the homeowner leaves the home, dies or fails to maintain the property, pay homeowners’ insurance or property taxes.

The upfront fees, interest and closing costs can be much higher than on home-equity loans.

This is why the industry pushes them so hard.

While there are no required monthly payments on a reverse mortgage, the interest is added to the loan balance each month, and so the rising loan balance can grow to exceed the value of the home.

This is the aspect of reverse mortgages I despise. Once people start tapping their equity, lenders and their compound interest will consume most or all the equity in the home before the senior dies.

Compound interest grows like cancer. if there are no payments, as there aren’t in a reverse mortgage, if given enough time compound interest consume everything. Would you like to spend your retirement worried about running out of money? Let’s imagine a few scenarios and see how you feel about this.

I could’ve used that money

Imagine your late 60′s, your children are stable and prosperous, so you decide you are going to blow a little of their inheritance. It’s your money, you can do what you want with it; besides, the kids don’t need it.

So you take out a reverse mortgage, or worse yet a HELOC, and you spend a little money. You don’t go overboard and spend your house, but you do spend enough that you feel worried that you might need it for yourself someday, so you stop using it.

After a while you forget about the loan since you aren’t making payments, and you go about your life. Years go by, and your in your mid 80s, and you want or need some elective medical procedures that require you to come out of pocket. You remember the old credit line and you dig for a statement. You open one up and realize the debt grew as fast as your house went up in value. You still have a little equity, but the debt cancer consumed everything you once had. You can’t afford your operation and you languish in discomfort in your final days — all because you took on that invisible Ponzi debt early in your retirement.

Riding the equity wave onto the rocks

Or imagine you are of retirement age, and you rationalize how you worked hard all your life so you deserve a few indulgences. You become a Ponzi accustomed to your great new life. This works great as long as you manage your debt in a sophisticated manner, right?

You do well until house prices crash again, your credit lines are cut off, and you lose your home. If your lucky one of your children is welcoming. If they’re not, your life really sucks.

Recognizing the cancer debt

At some point, seniors who take on reverse mortgages recognize them for what they are: a malignant financial cancer. These debt tumors grow until they crowd out home equity. There is no cure, and the tumor cannot be removed without selling the house. The only cure is prevention.

It’s worse than gambling

Nearly everyone who has gambled in Las Vegas has had a time when they lost more than they wanted to. Depending on how irrational you get, the financial pain can be mild or extreme. But when you lose in Las Vegas, your done. It’s over. The loss doesn’t get any worse. Your mistake doesn’t haunt you for the rest of your life. Reverse mortgages are different. If you make a mistake and take on a reverse mortgage, the losses of equity due to compound interest go on and on and get bigger and bigger.

It must be horrible to realize you have a financial leak you can’t plug without going back to work or selling the house to pay off the debt. Your debt will continue to grow until you die.

The loans represent a small corner of the national mortgage market, with only about 2% to 3% of eligible households using them, according to the CFPB. But studies show demand is growing, expanding the pool of 580,000 currently outstanding, according to Reverse Market Insight, a data provider and newsletter on the industry.

I am relieved to discover that so few of these financial cancers are growing on seniors.

Peter Bell, head of the National Reverse Mortgage Lenders Association, said better consumer education is necessary, and he shares concerns about misleading advertising and scams, adding that most consumers who have the loans are satisfied.

Seventy percent of borrowers are taking out the proceeds as a lump sum, as opposed to a line of credit or stream of payments, according to the bureau’s study. Such a move could result in borrowers having trouble paying taxes and insurance on their homes, which could put them at risk of default.

That is the worst possible scenario. The big lump sum spends fast, and once it’s gone, it’s gone. The debt will live on — and grow — forever.

Monica Newton, a 68-year-old resident of Chireno, Texas, said she has had troubles with unexpected bank fees and charges on her reverse mortgage, but she said in general the product is “really good for old folks” who aren’t concerned about leaving their homes to their kids or other family members.

Ms. Newton used cash to purchase her home for about $140,000 and decided to take out a reverse mortgage about five years ago when she needed extra money to cover retirement expenses. She said she is worried about being able to keep her house maintained to her lender’s standards.

One more thing to worry about in retirement. I think I will pass. I hope you will too.

He left some behind

Sometimes Ponzis were at least trying to keep their debts under control. The former owner of today’s featured property still imploded, but he didn’t max out his borrowing to match the full appraised value. If the bank gets their asking price on this one, they will not lose money. That’s a first.

  • The former owner paid $117,500 on 10/4/1996 using a $112,000 first mortgage and a $5,500 down payment.
  • On 3/31/1998 he refinanced with a 110,700 first mortgage actually paying down the balance.
  • On 2/28/2005 he refinanced with a $170,000 first mortgage.
  • On 12/16/2005 he refinanced with a $220,000 first mortgage.

Apparently, that was too much. The lender foreclosed and bought the property for $229,500 at auction.

Aliso Viejo Overview

Median home price is $334,000. Based on a rental parity value of $542,000, this market is under valued.

Monthly payment affordability has been improving over the last 7 month(s). Momentum suggests improving affordability.

Resale prices on a $/SF basis increased from $241/SF to $242/SF.

Resale prices have been falling for 12 month(s). Price momentum suggests falling prices over the next three months.

Median rental rates increased $33 last month from $2,215 to $2,249.

Rents have been rising for 12 month(s). Price momentum suggests rising rents over the next three months.

Market rating = 8

Proprietary OC Housing News home purchase analysis  

12 HEADLAND Pl Aliso Viejo, CA 92656 

$274,800    ……..    Asking Price
$117,500    ……….    Purchase Price
10/4/1996    ……….    Purchase Date

$157,300    ……….    Gross Gain (Loss)
($9,400)    …………    Commissions and Costs at 8%
============================================
$147,900    ……….    Net Gain (Loss)
============================================
133.9%    ……….    Gross Percent Change
125.9%    ……….    Net Percent Change
5.5%    …………    Annual Appreciation

Cost of Home Ownership
——————————————————————————
$274,800    ……..    Asking Price
$9,618    …………    3.5% Down FHA Financing
3.62%    ………….    Mortgage Interest Rate
30    ………………    Number of Years
$265,182    ……..    Mortgage
$80,079    ……….    Income Requirement

$1,209    …………    Monthly Mortgage Payment
$238    …………    Property Tax at 1.04%
$0    …………    Mello Roos & Special Taxes
$69    …………    Homeowners Insurance at 0.3%
$276    …………    Private Mortgage Insurance
$277    …………    Homeowners Association Fees
============================================
$2,069    ……….    Monthly Cash Outlays

($182)    ……….    Tax Savings
($409)    ……….    Equity Hidden in Payment
$11    …………..    Lost Income to Down Payment
$54    …………..    Maintenance and Replacement Reserves
============================================
$1,544    ……….    Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$4,248    …………    Furnishing and Move In at 1% + $1,500
$4,248    …………    Closing Costs at 1% + $1,500
$2,652    …………    Interest Points
$9,618    …………    Down Payment
============================================
$20,766    ……….    Total Cash Costs
$23,600    ……….    Emergency Cash Reserves
============================================
$44,366    ……….    Total Savings Needed
——————————————————————————————————————————————-

[idx-listing mlsnumber="S703064" showpricehistory="true" showlocation="true"]

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