So much has been written about traditional mortgages that many people forget about the sometimes-very-useful tool called a reverse mortgages. It sounds simple enough, and in concept it is. For comparison purposes, remember that a traditional mortgage is one in which you borrow against your home, receive a lump sum from the lender and immediately begin making payments over some stipulated time until the loan is paid off. A reverse mortgage is one in which you borrow against your house, but you don’t start making payments, and neither the loan or interest is paid until the very end.
The whole point of a reverse mortgage is to help your cashflow, so the “payments” are deferred until you either die or move, at which time the house is sold. The proceeds of the sale are first used to pay off the loan, including interest earned over the years. Only then would the borrower or his/her heirs receive any remaining amount.
Several years back, there weren’t that many options for people who wanted to consider reverse mortgages. Now, there are literally dozens of banks and other mortgage lenders offering an assortment of structures and payment options. In some instances, the minimum age has been lowered to 60, enticing a whole new generation of seniors to consider this technique. In other instances, lenders are now willing to lend against vacation homes or even to consider “jumbo” reverse mortgages for as large as several million dollars. The bottom line is that lenders want to lend more money to an even greater number of people than they had ever considered lending to before.
The use of reverse mortgages is also changing. Historically, it was almost always viewed and used as a last ditch effort to help an elderly person meet basic living expenses and/or avoid financial ruin. The thought was that and elderly person with cashflow problems but a lot of equity should be able to tap into that equity without incurring extra cashflow burdens. In response, banks lent the elderly person an amount of money, which, when added to the interest that would accrue over the life of the loan, would be less than the value of the house. Because lenders had to be careful that too much interest didn’t pile up and thus create a debt larger than the value of the home, the lenders usually made reverse mortgages to people who were very old. The odds that they might live too long were thus minimal. Advance rates were also kept fairly low, and very few seniors ever lost their homes prematurely.
Today, the same principals and concerns apply, but because of the dramatic run-up in home values and the tremendous increase in equity, lenders have been willing to lower the minimum age without increasing the risk that they would end up with a loan larger than the value of the house that had to be sold to repay the loan. Additionally, as seniors have become more financially astute, they have come to realize that their house isn’t just a “home”, it is also an appreciating asset which can be tapped for extraordinary expenses, like around-the-world vacations, special gifts to Grandkids, or to fund various estate planning techniques.
Since seniors are now less likely to view reverse mortgages as a sign of desperation, and now look at them as just another planning tool, it’s not surprising that lenders have responded to this
New demand has created more products with more bells and whistles attached. Therein lays the danger. As in any financial dealings, the market is full of honorable people and sharks.
People considering a reverse mortgage need to look at the interest rate being charged, the underlying index used in calculating that rate, the fees charged to put the loan together and any conditions which might force the home’s sale earlier than the borrower might want. This old stodgy marketplace has become a new vibrant and freewheeling market with lots of options and lots of charlatans.
The amount of razzle-dazzle being thrown at seniors in the form of advertising and marketing materials warrants close review and some caution. The most important thing to realize is that using a reverse mortgage unwisely means that you can lose your house. In a worst case scenario, someone would use a reverse mortgage to finance an extravagant lifestyle, which they really can’t afford and should curtail. The danger is that the reverse mortgage masks this fact, because it all of a sudden drops a substantial amount of money into the old checking account, and the profligate borrow now feels even more emboldened to live lavishly. Ultimately in this tragic example, the high-living, unwise borrower runs out of money – again! – and finds that there is no more equity to borrow. Since they can’t afford their lifestyle, they’re forced to move, which triggers the sale of the house. The lender takes the sale proceeds, which can in certain instances equal the entire value of the house, and our hapless borrower and high-spender is now worse off. They have lost their primary asset and have to downsize much more substantially than they ever would had to if they had only learned to control their spending.
Reverse mortgages, just like any form of debt, can be a very useful tool. They are a bit more dangerous than other forms of debt, because the repayment of this type of debt doesn’t slap you in the face every month, but instead creeps up on you. The blessing of “regular” debt is that almost immediately after borrowing, you have to start making payments. Those payments serve as a constant reminder that you have obligations to meet and that you need to be a good steward with your cashflow. As the piper is being paid, you instinctively know whether or not you like the tune. With a reverse mortgage, you might not even know that the piper will be playing a very somber, mournful tune until it’s too late.