Reverse mortgages, which allow seniors age 62 or older to tap into their home equity and receive an annuity payment during their retirement years, have grown in popularity, but so have the potential pitfalls.
Reverse mortgages advertised on TV sound like a super deal for seniors, but they are complicated and expensive. The anticipation of monthly income from a reverse mortgage is often overshadowed by misunderstandings over how these agreements work.
Like a traditional home mortgage, reverse mortgages accrue interest over time, and lenders charge an origination fee of up to $6,000 as well as annual charges for loan maintenance and mortgage insurance. Moreover, reverse mortgages can go into default if a borrower fails to pay property taxes or homeowner’s insurance or maintain the home.
Double the Defaults
Reverse mortgages have a default rate of 9.5 percent. This is almost twice the default rate of traditional home mortgages.
The Federal Housing Administration insures reverse mortgages, which provides lenders with a strong incentive to issue them, because they can claim compensation in the event of a default. But this government support means taxpayers could foot the bill for any number of defaulted mortgages.
In 2012, the FHA had about $140 billion in outstanding reverse mortgage loans. This means a default rate of nearly 10 percent could cost taxpayers billions of dollars.
Reverse mortgages allow homeowners age 62 or older to borrow against their home equity. They may receive a steady stream of income or a lump sum payment or draw from a line of credit. Reverse mortgages do not have to be repaid by the borrower, but once the borrower dies, the lender can sell the home in order to recoup the loan balance. If heirs wish to keep the home they must pay most of the outstanding loan balance through other means.
FHA Insurance Backstop
If the loan amount exceeds the value of the home when the loan comes due, the house becomes the property of the lender. If proceeds from the sale of the home are insufficient to pay the outstanding loan balance, lenders can file an insurance claim with the FHA.
A single individual must be at least 62 years old in order to qualify for a reverse mortgage. For a married couple, both spouses must be at least 62 years old.
The loan is not without cost. Like a conventional mortgage, reverse mortgages accrue interest, but the interest is not due until an event occurs that triggers repayment. Lenders also charge up-front fees, which include:
- Mortgage insurance, which is charged as both an up-front fee ranging from 0.02 percent to 2 percent (depending on the specific loan terms) and an annual charge equal to 1.25 percent of the loan balance.
- An origination fee based on the loan amount, but not more than $6,000.
- Miscellaneous service fees.
Lenders subtract these fees from the lump sum or monthly payments the borrower receives.
Although reverse mortgages are limited to seniors, borrowers are applying at earlier ages. According to a Met Life survey, the average borrower is 71.5 years old, but one in five borrowers are ages 62 to 64.2. Two-thirds of reverse mortgage borrowers are using them to pay down debt (including conventional mortgage debt), while only 27 percent use the mortgages to enhance their lifestyle.
Younger borrowers are far more likely to have mortgage debt than older borrowers, with or without other types of debt.
- Some 70 percent of borrowers under age 70 had mortgage debt, with or without other debts.
- Only 16 percent of borrowers under age 70 had no debt at all.
- About 62 percent of borrowers age 70 and over had mortgage debt, and only 25 percent had no debt at all.
The survey also found about one-third of homeowners using reverse mortgages have a mortgage balance of at least half their home value. This troubling trend will increase as more baby boomers enter retirement with mortgage debt than previous generations.
Rising Borrowing Limits
The Housing and Economic Recovery Act of 2008 (HERA) capped the origination fee lenders could charge borrowers, which led to fewer lenders offering reverse mortgages. On the other hand, HERA also increased the maximum loan amount to $417,000, surpassing the previous limits based on home values in the county where the house is located, which were often much lower.
The American Recovery and Reinvestment Act again increased the limit in 2009 to $625,000, thus giving more lenders an incentive to offer reverse mortgages. These changes appeared to reinvigorate the reverse mortgage market:
- A record number of reverse mortgages was issued in 2007 to 2009, with an average loan amount of $157,000 in 2007 and $150,000 in 2008.
- The issuance of new reverse mortgages rose to more than 114,000 in 2009, and the average loan amount peaked at $194,425.
- By 2011 the number of new reverse mortgages fell to 57,774—the lowest since 2005—likely due to declining home values after the housing bubble burst.
With a much higher default rate than traditional mortgages, reverse mortgages and their inherent risks should be left up to the market, not the Federal Housing Administration. If lenders cannot and will not bear the risk, the reverse mortgage market should not exist.
Pamela Villarreal ([email protected]) is an economist and senior fellow at the National Center for Policy Analysis. This article is excerpted from her NCPA Issue Brief, “The Ups and Downs of Reverse Mortgages.”