The Consumer Financial Protection Bureau (CFPB), an agency created under the Dodd-Frank legislation (and whose creation I applaud), recently released a report on reverse mortgages. The report is quite negative — in my view, excessively negative — and the press summaries omit many of the nuances of the original document, which makes it sound even more negative than it is. Reverse mortgages, which allow homeowners to tap their home equity, are instruments that many Americans are going to need in order to have any chance of a decent retirement. To the extent that flaws exist in the reverse mortgage market, they need to be fixed. But a future without reverse mortgages would be a very grim one indeed. (Full disclosure: I am an investor in and a member of the Board of Directors of Longbridge, a start-up company that has been formed to provide reverse mortgages in a socially responsible fashion.)
Reverse mortgages are a special type of home loan for older Americans that allow them to borrow against their home and defer the repayment of the loan until they die or sell their home. The most important reverse mortgage currently on the market is the Home Equity Conversion Mortgage, or HECM, which is issued and insured by the Department of Housing and Urban Development (HUD). HECM loans are available to all homeowners age 62 and older who own their primary residence free and clear or who can pay off their mortgage easily with the proceeds of the loan. (In 2010, HUD introduced the HECM Saver, with lower upfront loan closing costs for homeowners who want to borrow smaller amounts.)
The maximum loan amount depends on three factors. The first is the value of the home; the higher the value (up to the Federal Housing Administration’s insurance limit of $625,000), the more can be borrowed. The second is the interest rate; interest payments are added to the principal over the life of the loan, so the lower the interest rate, the more can be borrowed. The third is the age of the borrower; since interest payments accrue over time, a shorter loan period means the amount an individual can borrow will be larger.
Borrowers can take their money in regular payments for a fixed term, can take regular payments for as long as they stay in their house, can get a line of credit, or can select some combination of these choices. They can also choose to receive the entire amount in one lump sum.
Americans are going to need reverse mortgages. Most households are going to find that their retirement incomes fall short of their retirement needs and will experience a decline in living standards. Being able to tap their home equity — often their single largest asset — provides a source of income that could supplement Social Security and the income generated by their meager 401(k) balances. To date, however, the reverse mortgage market is small; only about 2% to 3% of those eligible take out such a loan.
The CFPB identified three major concerns:
1. The products are complex, and the existing tools and counseling do not enable consumers to make good decisions.
2. Misleading advertising, spouses’ lack of knowledge about the transaction, and the failure to pay insurance and taxes creates risks for consumers.
3. Recent trends toward taking out loans at younger ages and withdrawing more of the money upfront (often to pay off their traditional mortgage) put consumers at risk.
These concerns are legitimate, but manageable. The products are more complex than traditional mortgages and not suitable for everyone. Careful counseling is essential so that providers sell these products to appropriate people. Misleading advertising should be identified and stopped; spouses, even if not co-borrowers, should be provided with information and required to sign off on the transaction; and lenders should make sure that borrowers have enough to cover taxes and insurance by either lending only to those with some financial cushion or withholding enough to cover these payments. Taking reverse mortgages at younger ages, the final concern, may be a sensible strategy if used to pay off traditional mortgages, but not to gamble in the stock market. In either case, the lender should make sure the consumer has the required financial cushion before taking out a reverse mortgage.
The bottom line is that the reverse mortgage market should be fixed to the extent that it’s broken, but dismissing the product will doom many households to poverty in old age.