A common thought upon first learning about the HECM program is that it seems almost too good to be true and that there must be a catch involved. I am often asked about reverse-mortgage risks. I summarize here their potential risks so that the discussion is clear, making it easier for readers to analyze the costs and benefits of a variable-rate HECM.
Program Complexities Can Lead to Misunderstandings
When discussing reverse-mortgage risks, the first matter to emphasize is that many of the commonly mentioned risks involve misunderstandings on the part of borrowers or heirs about how the program works. In 2015, the Consumer Finance Protection Bureau published two reports about reverse mortgages that describe risks and complaints about the program. First, their “Snapshot of Reverse Mortgage Complaints: December 2011–December 2014” was released in February 2015. It notes that for the three-year period investigated, reverse-mortgage complaints represent about 1 percent of the mortgage complaints received by the CFPB and that the reverse-mortgage market size is about 1 percent of the total mortgage market. Thus, there is not a disproportionate number of complaints about reverse mortgages.
For more information, download our Reverse Mortgage 101 Cheatsheet.
After reading this article, you should recognize that many of the complaints discussed in the CFPB report stem from misunderstandings on the part of those lodging them. Nonetheless, these complaints do allow us to reflect again on some of the complicated features of the HECM program and the misunderstandings they may generate.
The most common complaint category (38 percent of complaints) relates to problems when someone is unable to pay, such as a borrower’s desire to refinance a loan when home equity is insufficient to do so. Borrowers also complain about being unable to change loan terms, like seeking to lower interest rates or the lender’s margin, or feeling that the variable-rate portion of the effective rate has risen too quickly. Borrowers also complain about not being able to add additional borrowers to the loan in order to avoid the loan balance becoming due. For instance, adult children complain about not being able to be added to the loan as borrowers or at least to become eligible nonborrowers. As well, nonborrowing spouses have complained about not being able to be added as borrowers after the loan has commenced.
Due to the actuarial nature of the program and how the principal limit factors are determined, it should be clear to readers that these types of requests are not allowed and not reasonable. Having more younger borrowers added to the loan would increase the time to loan maturity and would require a lower initial principal limit factor than already provided. As well, for the case of nonborrowing spouses, the protections for eligible nonborrowing spouses were added near the end of the period under review (August 4, 2014), which should at least reduce these types of complaints. Nonborrowing spouses must remember, though, that they are not borrowers and will not be able to continue to access funds from the line of credit once the borrower has left the home.
In 2014, the Consumer Financial Protection Bureau conducted focus-group studies in which consumers were shown advertisements about reverse mortgages and asked for their perceptions. They provided the results of this investigation in a June 2015 report entitled, “A Closer Look at Reverse Mortgage Advertisements and Consumer Risks.” Some of those in the focus group did not understand that a reverse mortgage would have to be repaid in the future, or that there are fees or interest involved. Rather, they viewed it as a type of welfare program directly administered by the federal government. Others viewed the loan balance as a way to spend home equity, not understanding the mechanism whereby this would reduce the value of their share of home equity in the future. Still others thought that the “tax-free” nature of reverse mortgages would mean that property taxes would no longer have to be paid. Others misunderstood explanations about those able to stay in the home as their not being subject to any of the eligibility requirements for the loan. The explanation of reverse mortgages that I have provided, hopefully, means that you well understand these aspects of them.
This is an excerpt from Wade Pfau’s book, Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement (The Retirement Researcher’s Guide Series), available now on Amazon.