Reverse Mortgage Abuse on the Rise

Lawmakers and regulators warn of predatory practices in the growing reverse mortgage market.

EDITOR'S NOTE: This article was originally published in the May 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.

After her husband died in November 2003, Ernestine Boach met with a financial adviser, who told her that her $60,000 life-insurance policy was inadequate. He assured Boach, who had just retired as a clerk for a local school district, that he could boost the value of the estate that she would leave to her daughter. And, he said, it wouldn't cost her a cent. "He said he had a wonderful deal for me," recalls Boach, of Chula Vista, Cal. "He said all I have to do is buy a reverse mortgage."

What she really bought though was a lot of trouble, according to a lawsuit she later filed in California Superior Court. The adviser, who was an insurance agent, called in an employee of Financial Freedom Senior Funding Corp., a large reverse mortgage lender based in Irvine, Cal., who arranged a $171,000 loan.

With part of the reverse mortgage, Boach bought a $250,000 life-insurance policy. The agent also sold her an immediate annuity for more than $44,000 and told her that the $4,000 annual payout would pay the insurance premium, the suit alleges. In addition, Boach bought an $80,000 deferred annuity, which, she says she was told, would eventually pay back the reverse mortgage. Her heirs would get the house free and clear as well as the life-insurance proceeds.

After signing on, Boach began to worry. A real estate agent crunched the numbers. Within five years, she would owe $240,000 on the reverse mortgage, for principal and interest. By then, Boach says, the $80,000 annuity would have grown to only $97,000. Plus, the suit says, once the immediate annuity ended in ten years, she'd have to pay the life-insurance premiums out of pocket.

Boach wanted out. To pay back the reverse mortgage, she took out a home-equity loan, which will cost her $1,000 a month, she says. Boach, now 67, says her blood pressure has shot up after four years of fretting. "It will affect me for the rest of my life financially and health-wise," she says.

Michelle Minier, chief executive officer of Financial Freedom, says the suit is "baseless and meritless." But she says the company "settled for nuisance" with Boach for a small amount.

Minier notes that all customers must sign an "annuity disclosure," which states that the lender does not require or arrange the purchase of annuities in connection with its loans. "We generally discourage the use of reverse mortgages to fund an annuity," Minier said in an interview. "But there are situations where it might be completely appropriate." She says the company encourages customers to seek advice from family members and independent financial advisers.

The Wild and Woolly Market

Sad to say, Boach is not the only borrower who's complaining. Seniors are increasingly becoming targets of aggressive marketers who are selling reverse mortgages that many customers don't need or understand, according to members of Congress, government regulators and consumer advocates. And as in Boach's case, some promoters are accused of persuading seniors to use loan proceeds to buy annuities and other high-commission products.

The marketing blitz, combined with an aging population, has fueled a dramatic increase in the most common type of reverse mortgage, the federally insured Home Equity Conversion Mortgage (HECM) loan. The number of HECM loans rose to 107,558 in 2007, up from 6,640 in 2000, according to the National Reverse Mortgage Lenders Association.

As the number of loans has grown, angry homeowners are filing lawsuits against lenders, alleging predatory practices. Meanwhile, the Florida Attorney General and the Financial Industry Regulatory Authority, which oversees securities firms, issued alerts this year to warn about the risks of reverse mortgages (read FINRA's tips at

Congress is getting into the act. In December, the Senate Special Committee on Aging held hearings on abusive sales practices. Senator Claire McCaskill (D-Mo.), who chaired the hearing, wrote an amendment to major housing legislation that would prohibit lenders from requiring seniors to purchase an annuity or other products when taking out a reverse mortgage. "This is the wild, wild West out there selling a financial product that's expensive and complicated to our elderly," she said on the Senate floor.

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Lenders argue that most brokers do not engage in abusive tactics and that the loans have helped thousands of people. "Some folks are in a situation where they need to generate some cash flow without leaving their house," says Mike Gruley, president of First Financial Reverse Mortgages, a lender in Northville, Mich. "Other folks want a better quality of life."

Consumer experts worry that abuses could multiply as more baby-boomers turn 62, the age at which borrowers become eligible for the loans. With the traditional- and subprime-mortgage markets shrinking, brokers are moving in droves into reverse mortgages. There were 1,667 lenders selling reverse mortgages in March -- a nearly 25% jump since last August, according to the lenders association.

Many lenders are aggressively recruiting loan officers with promises of lucrative sales. "The Easiest Sale You've Ever Made!" advises one mortgage company that conducts sales workshops for brokers. It notes that six sales a month could generate "up to $44,833 in monthly commissions."

In early May, brokers and lenders were to attend a conference in Las Vegas to learn how to sell the loans, including tips on "overcoming objections" by prospective borrowers. Notes the Web site advertising the conference: "The Reverse Mortgage Industry is a 'gold mine' niche with only 1% saturation & 80% growth over the past year."

One conference participant is T&J Consulting Firm, based in Carlsbad, Cal., which helps mortgage brokers meet federal requirements and recruit and train brokers. Tracie Gressmen, director of sales, says many lenders want to get into the business because the eligible population is growing. Seniors, she says, "have the most equity and the lowest income. They're going to realize that the home they bought 30 or 40 years ago is sitting there not making much money." She says that customers should consult with an independent adviser before taking out a loan.

With so many sellers jumping on the bandwagon, expect to be deluged by solicitations. This hurly-burly market is a far cry from what Congress envisioned when it created reverse mortgages as a last resort for house-rich, cash-poor seniors. These products allow homeowners 62 and older to convert part of their home equity into a monthly stream of income, a line of credit or a lump sum. The loan comes due when the last borrower sells or dies.

Some retirees are using these loans to take fancy trips, start small businesses and pay for their grandchildren's college. But upfront fees are substantial. And many borrowers do not realize that the loan could chip away at their equity over time, perhaps leaving little or no assets to cover future needs.

Conservative financial planners and consumer experts suggest that seniors should consider a reverse mortgage only when they need cash for essential expenses, such as home repairs and medications. Or at the very least, don't go overboard with your spending. "A reverse mortgage shouldn't be seen as a cost-free way to enhance your lifestyle in retirement," says John Gannon, senior vice-president at FINRA. "It's an expensive option, and people need to realize they're reducing the value of their home."

Don't Borrow to Buy an Annuity

While tapping your home equity to buy a boat could be shortsighted, lawmakers and consumer advocates are most worried about cases similar to Boach's. An AARP survey showed that 9% of all prospective borrowers were invited to buy other financial products with their payouts. Warns Trish Kauker, vice-president for reverse mortgages at WSFS Bank, in Hockessin, Del.: "Anyone who tries to push another product should be ruled out immediately."

Prescott Cole, senior staff attorney with the Coalition to End Elder Financial Abuse, explains why. Say you take out a $100,000 mortgage to finance a ten-year deferred annuity. By the time you start getting annuity payouts, you may owe $183,000 on the mortgage in principal and interest, he says. Because the growth of the deferred annuity is likely to be smaller than the accrued interest of the mortgage, Cole says, the annuity "will never make enough to offset the cost of the loan."

Also, using the proceeds to buy a deferred annuity defeats one purpose of a reverse mortgage, which is to provide seniors with liquidity. A senior who later needs the cash is likely to face big penalties if he or she needs to pull money from the annuity early.

That's a scenario that Mary Munoz described in a lawsuit in federal court. Four years ago, at age 76, the Los Angeles resident was approached by a woman who called herself a "certified senior adviser," according to the lawsuit filed in November 2007. The adviser, who was actually an insurance broker, persuaded Munoz to take out a reverse mortgage and brought in a loan officer, according to the suit. Munoz took out a $209,282 reverse mortgage.

Munoz used $79,000 to pay off the original mortgage, as required under HECM regulations. The broker, according to the suit, sold Munoz a $60,000 deferred annuity and a $20,885 immediate annuity, assuring her that they would grow to provide both ongoing income and to repay the loan when Munoz died.

But Munoz was forced to withdraw more than $26,000 from the deferred annuity to make home repairs required by the loan. The early withdrawal triggered huge surrender charges.

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