Reverse mortgages lure users — and abusers
Nov 25, 2008 | 631 views | 8 
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While reverse mortgages, which emerged less than 20 years ago, rise in popularity, predators pounce on unwitting prey prodded by need or greed to take advantage of the equity in their home.
A reverse mortgage sounds so simple. If you’re 62 years or older, you may qualify.
The process also sounds fairly simple. Find a company that offers reverse mortgages, get your home appraised -- only the home you live in can be used for a reverse mortgage -- and they'll let you know how much money you can borrow.
You can take it in a lump sum, monthly payments, or as a line of credit. The loan doesn’t have to be repaid until you sell the house or no longer live in it, either through relocation to another address or your death.
The first thing any legal, financial or tax advisor or consultant with a conscience will tell you is this:
“If you don't need the money, don’t do it.”
For one thing, the up-front fees are hefty, as high as 10 percent in some cases. So if you qualify for a $150,000 reverse mortgage, you lop $15,000 off it right at the beginning. Interest rates also tend to be higher than conventional home-buyer mortgages.
Charlatans hover around seniors who look like they might be open to improving their fiscal future by exploiting the equity in their home.
The trail left by these crooks is strewn with seniors who were conned into thinking they could not only secure their future but assure their sons and daughters of a much larger estate.
How?
The sales pitch varies.
By getting a reverse mortgage, the homeowner can use the money to buy insurance policies, annuities or whatever else the scammers are selling so they can pocket hefty commissions and transaction and management fees before walking away from the dazed dupe left with a shell of what he or she owned before acquiring the reverse mortgage.
These high-pressure predators point out the reverse-mortgage money can be used to buy a life insurance policy that will benefit your heirs and add a couple of annuities, one of which will pay the insurance premiums and another that will grow into enough money eventually to pay off the reverse mortgage.
Often, the victim is led to believe that an annuity that repays the loan is required as a condition of approval for the reverse mortgage to remove any concern about the lender being repaid.
Bedazzled by such munificent machinations, the victims don’t see how they can lose.
But the devil is in the details and decimal points.
If you are older than 62 and you have a hefty equity in your home and you do need the money, explore reverse mortgages insured by the Federal Housing Administration, which requires the applicant to discuss all the issues with an agency-approved financial counselor before initiating the process.
The session covers such topics as the cost of obtaining a reverse mortgage, avoiding fraud, and financial alternatives. One alternative to consider, for example, is a home-equity loan.
The thing to keep in mind is that a reverse mortgage is not necessarily a vehicle that will take you to Easy Street. It could be just the reverse.
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As a tax advisor I am surprised by some of the tax advice. First, paying down a reverse mortgage does not guarantee interest deductions. The pay down is applied against upfront fees and costs, service fees, and FHA insurance premiums before being applied against interest deductions as contracturally stated in the mortgage note. One should check with the service provider as to how much of the payments will be considered as paid against interest.
Second, if the borrower has few other itemized deductions, the available interest deductions may do nothing or little to reduce the income tax liability from minimum IRA distributions. One must understand something about the standard deduction and itemized deductions generally to present the benefits of paying down a reverse mortgage liability. But I agree it should be considered.
For too many HECM borrowers, the interest is not interest related to acquisition debt but is home equity debt, not deductible for alternative minimum tax purposes at all. Where is this disclosure by the commentators?
Finally, it is not true that reverse mortgage proceeds are nontaxable. They are just as taxable as the proceeds from any other nonrecourse loan; so is the debt on accrued but nondeductible interest. What happens to the income tax basis of the home if proceeds are received when the amount due exceeds the value of the home or when the loan becomes due and payable and the lender does not receive payment in full from the borrower?
I guess one commentator has never heard of possible gain from foreclosure that exceeds the available exclusions for gains on the sale of a principal residence.
Yes, the article author is biased but so are too many of the commentators. Many of whom are just as wrong. For example to claim that the HECM rate is now less than 3% is to ignore that most non-HECM reverse mortgages are over 8%. Then there is the misleading idea that a monthly adjusting HECM rate with a cap of 10% more than its initial rate can be compared to a fixed rate forward loan of 6%. Is this being done for "marketing" purposes?
The Total Annual Loan Cost schedule does not provide the information that most of the commentators assume. It is based on assumptions which if believed as many of the commentators seem to have done, makes a donkey out of them and a donkey out of those who believe what they write. The TALC as it is called is based on the note rate staying constant which unless it is a fixed rate reverse mortgage, it will not. Also there is an assumption on when funds will be received if not all received upfront. If there is no use of the line of credit or available proceeds by the borrower, the APR rate is 100% using the TALC concepts.
What the article author did by mixing up the use of the proceeds with the loan is poor but so are many of comments by the "learned" commentators.
Its possible the author is referring to TALC (Total Annual Loan Cost) and the effect of the fees being expressed as part of the interest rate. Even so its misleading because as you say the nominal rates are substabtially lower for a Reverse Mortgage in most cases. TALC is a hard concept for many people to get theri heads around and if thats what the author intended they are only causing confusion over inexact use of terminology.
“If you don't need the money, don’t do it.”<<
This is not true. Legal, financial and tax advisors who take the time to learn about the FHA insured HECM reverse mortgage are beginning to understand what an important and helpful financial tool it for people planning or in their retirement.
First, the FHA has recently enacted legislation prohibiting the marketing of insurance and annuity products with the FHA insured HECM reverse mortgage. Like the commentator below, I have worked with thousands of folks who have gotten a reverse mortgage and no one has been unhappy about the decision. It really does allow folks to have an option to make positive changes in their lives.
The usual negative news article about reverse mortgages are not that the reverse mortgage was bad but that the use of the funds was bad-people splurging and spending it all or buying an annuity product. Those folks could have just as easily made the same poor decision about the use of a home equity loan.
That said, most folks (and this is what I advise) prudently use the funds when they need it as they need it. Given all that, the facts are that folks who use a reverse mortgage appropriately as a financial tool (and that is all that a HECM reverse mortgage is-a financial tool that can be a benefit if used correctly), actually end up leaving their heirs or kids more money than people who do not use a reverse mortgage.
What you leave your kids isn't the house-you leave them everything. That includes not only the house but the tax deferred funds in your IRA, Keough or SEP. What happens when you spend $1,000 from your tax deferred funds? First, you spend $1,250 since you pay income tax on that withdrawal. Second, once you spend it, it is gone.
On the other hand, if you leave that tax deferred account alone and get the $1,000 instead from your reverse mortgage, what happens is (1) you do not pay the $250 in taxes since all reverse mortgage funds are income tax free and (2) once you spend the $1,000, it is not gone since you still own your home (which is appreciating over the long run) and since the HECM reverse mortgage Line of Credit is guaranteed to grow at an income tax free interest rate one half of one percent higher than the interest rate acruing on funds that you have actually used.
When you run actuarial projections (and I have run these projections with lots of folks, using the most conservative assumptions), the numbers clearly show that folks who use reverse mortgage funds instead of spending down their tax deferred savings end up being in a much stronger financial position. They are able to leave their tax deferred accounts intact to continue growing over time and that more than offsets the decrease in the home equity.
And how about the mandatory minimum distributions? Well, if you do not need those funds, you can use them to make a payment on your reverse mortgage balance. This has three positive effects. First, it creates a mortgage interest deduction that helps offset the income tax paid on the mandatory distribution. Second, it pays down your reverse mortgage balance. Third, every dollar for dollar that you prepay on a HECM reverse mortgage (and there are no prepayment penalties with the HECM) will increase your HECM Line of Credit by the same dollar for dollar amount meaning those funds are just as available to you as if you had put them in a savings account but with one very big difference. If you had left that mandatory distribution in your savings account, it would be a countable asset (money that you would be required to spend down in the case of a nursing home situation). If, instead, those funds are in your HECM Line of Credit, then they are not a countable asset since federal regulations deem HECM funds to be exempt from nursing home and Medicaid spend down requirements. In short, you have converted a countable asset into a non-countable asset.
That said, please understand that the HECM reverse mortgage, like all financial tools, is one option that you have among many options. The key is to get the education, from a knowledgeable professional, so that you can objectively decide if it is a financial tool that makes sense for your situation or if some other option would be better.
I'm so tired of hearing this statement ... I wish the folks who write these articles did more research instead of miminicking other Writers.
Today, November 26 2008, the interest rate for the most popular FHA-insured Reverse Mortgage program is 2.71%. The interest rate for a 30 year conforming mortgage is 6% (more then double). So why in the world would any Author say "interest rates for Reverse Mortgages tend to be higher"? They should spend a little time with someone like me first, ask questions, and then write a good solid truthful, informative and accurate article.
While the fees may seem high compared to other loans, this is not just another loan. It can't be compared to a traditional loan. The only thing that is similar with a traditinal loan is that you are borrowing money, and promising to pay it back. The loan repayment terms differ though. Also, you can't be foreclosed on with an FHA reverse mortgage for missing a payment because there are none, simply keep your taxes and insurance paid.
It is also important to discuss the FHA insurance with your loan officer, it makes up 50% of the closing costs, is the most crucial part of this loan, and makes these loans possible.
The interest rate is reasonably fair, in fact, almost too fair, currently under 3%. Fixed rate reverse mortgages are also available, and they hover around 6%.
The only negative articles I have read about reverse mortgages include the loan officer offering other products to the homeowner, such as deferred annuities. Look, folks utilize reverse mortgages to free up cash to make a difference in their lives today and tomorrow, and not to give it to someone to lock up for 7 or 10 years.
I could keep writing because I am so passionate about these loans. I have worked on over 500 of these loans since 2002, and have NEVER EVER had anyone come back and say they were sorry they did it. Yes, I do keep in contact with most of them. Most are happier in their lives today than they have been in a long long time.
One thing to leave you with: If you are an older homeowner and your retirement funds are battered down, does it make more sense to cash those out at their low prices to help you live, or utilize a reverse mortgage to free up some of your trapped equity? Also, does it make sense to keep puttin money into a depreciating asset? IE: mortgage payments, especially when homes are down 18% since last year, yikes!