Real Estate

A New Mortgage Mess on the Way?

Reverse loans are a boon -- but watch out for rotten sales practices.

By Anne Kates Smith, Senior Associate Editor

From Kiplinger's Personal Finance magazine, March 2008

Easily the biggest financial fear of elderly Americans is that they'll outlive their money. So it's easy to see why the $4 trillion of home equity that's wrapped up in the houses of America's senior citizens seems like an attractive solution to an underfunded old age. And as America ages, it's no coincidence that the market for reverse-mortgage loans is finally taking off.

Reverse mortgages allow homeowners 62 and older to turn equity into cash while living at home for as long as they wish. Borrowers receive a lump sum, monthly payments or a line of credit, and the loan comes due only when they move out or die. It is usually repaid by selling the house, with any leftover equity going to the homeowners or their heirs.

But as the industry grows, some see eerie parallels to the subprime mess roiling the country. Could reverse loans become the mortgage scandal of the next decade?

Complaints include misleading marketing tactics and, worse, pressure to buy inappropriate investment or insurance products with the proceeds of the loan. "People can end up in predatory situations," says Barbara Stucki, a home-equity expert at the National Council on Aging.

Peter Bell, president of the National Reverse Mortgage Lenders Association, says the bad actors are fringe players, not the headliners of the industry. "We're seeing some of the subprime players coming into our market," he says. His group is investigating direct-mail pieces that look like official government notices but are actually just loan pitches, and others that promise huge commissions for salespeople who bundle annuities with reverse loans.

A study recently released by AARP finds that nearly one in ten reverse-loan borrowers had other financial products recommended to them by lenders -- usually investments, annuities or long-term-care insurance.

"As a rule of thumb, if a lender suggests a sale, it's probably something you don't need or shouldn't buy," says Donald Redfoot, a policy adviser at AARP. It's rare that you'll come out ahead layering the costs of the financial products with those associated with reverse mortgages. Borrowers receive counseling as a matter of course before they can get a reverse loan, but government-sponsored programs are woefully underfunded. Sometimes counseling is paid for by the lender, raising questions about impartiality.

Even more troubling than fears of predatory lending are the high costs that plague reverse loans. The costs over the life of a typical government-insured loan for, say, $181,000 to a 74-year-old borrower in a $300,000 home, can add up to $30,000 -- not including interest, according to the AARP study.

The news isn't all bad. Most seniors with reverse loans are satisfied with them. And the market is luring more lenders, offering a wider selection of products and the potential for lower costs as competition increases. A year ago, loans were cookie-cutter. Now borrowers can choose from more than 20 different loan permutations -- and counting. Clearly, there won't be any problem tapping that $4 trillion in senior home equity. The challenge will be unlocking it wisely.

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