Oct012014

How reverse mortgages cause financial cancer and emotional pain

Reverse mortgages eat homeowner equity through the power of compound interest working against the borrower, much like the growth of cancer cells.

I’m not a big fan of debt, in case you didn’t notice. I don’t like consumer debt, and I really don’t like reverse mortgages. I recently wrote that Home ownership with no mortgage is the best retirement plan. It stands to reason that I view taking on mortgage debt in retirement as the worst retirement plan.

First, for those who aren’t familiar with reverse mortgages, let’s define what they are. 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, but many seniors default on the taxes and insurance and allow the property to be foreclosed on. 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.

Sounds like a good deal, doesn’t it? They give you free money, and you don’t have to sell your house. No wonder the loan is popular, particularly among spenders and Ponzis.

Love Them or Loathe Them, Reverse Mortgages Have a Place

SEPT. 26, 2014, By RON LIEBERToxic Mortgage Bomb Shelter

Executives from reverse mortgage companies know plenty about consumers’ feelings around inheritance. After all, they’re in the business of encouraging older Americans to drain equity now from homes they may pass on to their heirs in the future.

But dare to quote one of these people as a source in this publication, as I did last week, and this is the kind of vigorous reaction that comes from readers:

I can’t even imagine a scenario where a reverse mortgage should be considered anything but radioactive,” said one comment.

And: “They’re nothing but a scam that nobody with any common sense should fall for,” according to another.

These vehicles are the province of the most unscrupulous of lenders and would be outlawed in a more civilized society,” said a third.

It’s good to know lenders haven’t duped all Americans into being stupid sheeple.

These are easy things to say when you have enough savings or pension and Social Security income to get by. But given that older Americans’ homes are worth, on average, more than their other combined savings, there is a begrudging inevitability about reverse mortgages. As more people enter retirement in the coming decades with modest savings and no private pension, they’re going to need some of that home equity back during their increasingly long lives.

sheeple_banksUnfortunately, I believe he’s right. Baby boomers will likely turn to these mortgages in large numbers, particularly since we just reflated a housing bubble to provide them with equity.

It’s been fascinating to watch the reverse mortgage industry grow up — or try to — in recent years. On one hand, it’s always been filled with no-name companies using second-tier celebrities to try to sell seniors on the product. Unethical salespeople engaged in all manner of bad behavior, persuaded customers to pull equity from their homes and invest it in inappropriate financial products or to leave spouses off the property’s deed in a way that caused them to lose the homes later.

Take a bad product and sell it through dishonest operators, and you end up with a catastrophe.

Name-brand companies like Bank of America, Wells Fargo and MetLife fled the sector in horror. …

Good.

“When I look forward, I don’t see how people are going to have enough, I really don’t,” she said. People spend their adult lives paying off their mortgages, and those with pensions were often able to avoid using that home equity in retirement.

“Our assessment going forward is that it’s a luxury we’re not going to be able to afford,” Ms. Munnell added. “They are going to need money, and this is the place where the money is.” …

This is exactly why reverse mortgages will be popular with baby boomers. For many of them, the equity in their home is the only savings they have, assuming they didn’t already blow it with mortgage equity withdrawal.

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Lenders have asked the well-respected Mr. Evensky to use his research in new releases, he said, and are prone to wanting to oversell it or extrapolate it to other uses. The industry, where loan originations have fallen roughly by half in recent years, has a slight whiff of desperation about it.

Still, over the next five or 10 years, more people are probably going to need these loans whether we like it or not. It could happen if they’re completely out of money, in which case they may use so much of their equity for living expenses that there may not be much left if they later need to sell the house and move to a nursing home.

senior_eating_dog_foodReverse mortgages provide seniors with plenty of equity and limited income the ability to tap their equity to meet the needs of daily life. Basically, government officials 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.

Others may want to upgrade their standard of living in their golden years (and worry little about leaving an inheritance, which is certainly their right). …

Call the loans and the lenders and the executives who run them all the names you want. But the tool they sell is one whose time is coming, and people who refuse even to consider a reverse mortgage in the coming years may do themselves a disservice.

Let’s look at this with an open mind. Are there any circumstances where reverse mortgages would be a good idea?

Perhaps some seniors may want to live for the day and spend more while they are still young, healthy, and mobile enough to enjoy the money. They will have less material comforts later, but as long as they understand that going in, then they may enjoy it.

sea_lamprey_damageIf a homeowner discovers they are terminally ill, then perhaps going out with a bang might be warranted, but he or she should consider the needs of any survivors before spending everything. If there is no surviving spouse, and if the kids are well off, then why shouldn’t a terminally ill person spend everything possible to enjoy their final days?

Despite the few good uses of reverse mortgage, the pernicious financial cancer aspect of reverse mortgages are impossible to ignore. 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 consumes everything. Who wants to spend their 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 you’re 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, and why wouldn’t they be considering you were spending their inheritance. 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, you’re 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.

I will never use a reverse mortgage

I can honestly say I will never use a reverse mortgage. As a parent of a special needs child who will likely never hold down a job, I must leave a lifetime’s worth of earnings for him to have more material comfort than the minimum level of entitlement the State will provide. Given this reality, it’s unlikely I will blow my savings before I die. If my life circumstances were different, then perhaps I might think differently, but I know for myself, I will never use a reverse mortgage.

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