The phrase “demographic demand” refers to the idea that a person’s goals in obtaining credit may be influenced by age . The borrowing patterns of young people provide the most familiar example of this phenomenon. In general, young people have not had the opportunity to accumulate savings, but they have a high potential to earn income on an increasing scale. They most often seek out credit to enable them to purchase major items of property, such as cars, furniture, appliances, and houses. Lenders extend them credit on the strength of their ability to earn income. It is widely known that the fastest growing demographic group is not young people, it is senior citizens. When senior citizens apply for loans their goals are often the mirror image of those of younger people. Many senior citizens own major assets. They often own real estate outright, unencumbered by a mortgage. And they have often seen the value of their real estate rise considerably since it was purchased. Due to retirement, though, senior citizens’ incomes are diminished. Lenders have noticed these differing needs of borrowers based on age. They have begun to develop loan products to cater to the needs of older people. One of the product lenders have developed to meet this need is known as the “reverse mortgage.”
It is not difficult to trace the source of bad impressions and mistrust that predominate conversations about reverse mortgages. The practice of “Equity Sharing,” the predecessor of reverse mortgages is the source of much of the confusion about how reverse mortgages really work. In the stereotypical equity sharing arrangement, individuals would approach cash-strapped seniors and offer to make lump-sum or over time payments to them in exchange for having the senior sign a deed, naming the “benefactor” as joint owner. In scam awareness materials, senior advocates refer to this practice as “deed theft.”
Early in the reverse mortgage chronology, lending institutions perpetuated this reputation by inserting provisions into their reverse mortgage documentation that allowed them to claim all of the appreciation of the home on which they had issued a reverse mortgage. One such story occurred in Brigantine, N.J. “In 1988, Katherine and Harold Stephens, signed up for a reverse mortgage that guaranteed to pay them $312 a month for as long as they resided in their house near Atlantic City. At the time Katharine was 76 and Harold was 78. Harold later died, leaving Katharine living alone in the property. Like other reverse mortgages, the money sent by the lender each month represented a gradually growing debt that would have to be repaid when the owners sold the home or moved to a different residence or health care facility. The loan carried an annual interest rate of 11.5 percent, but it also had another problem. Buried in the contract block print was an equity provision. Besides the regular interest rate on outstanding balances, the lender received the right to 100 percent of all equity appreciation on the house from the day of settlement to the date of final sale or move out.” Stories like this have prompted states and the Federal Government to step in and regulate the reverse mortgage industry.
The first Reverse Mortgage was issued in 1961, by Nelson Haynes of Deering Savings and Loan in Portland, Maine to Nellie Young, the widow of his high school football coach. In the 1970’s various educational institutions were writing technical documents on this new breed of lending product. In 1975, Jack Guttentag of University of Pennsylvania’s graduate school, The Wharton School drafted "Creating New Financial Instruments for the Aged." Ohio took the lead on reverse mortgages in 1977, creating the first Reverse Mortgage Loan Program, "Equi-Pay." The following year, Wisconsin’s Bureau on Aging funded the "Reverse Mortgage Study Project" and the Wisconsin Department of Local Affairs and Development offered the first statewide deferred loan payment program. The first national "Reverse Mortgage Development Conference" was held in Madison, Wisconsin in 1979. Reverse mortgage education and development began to move across the country shortly after that, with San Francisco creating a Reverse Annuity Mortgage program and studies being completed in Cambridge, Massachusetts on "Unlocking Home Equity for the Elderly." National attention began to focus on this movement with a two-year "Home Equity Conversion Project" funded by the U. S. Administration on Aging and the endorsement of an FHA reverse mortgage insurance proposal in 1981 by the White House Conference on Aging.
Throughout the 1980’s, reverse mortgage, or Home Equity Conversion (HEC) programs gained national exposure via multiple publications, conferences, and media coverage in Newsweek, Time, U.S. News, and Good Morning America. The U.S. Administration on Aging funded research on federal issues around HEC programs and the U.S. Senate Special Committee on Aging staged the first hearings on reverse mortgages and subsequently issued a report citing the need for reverse mortgages in 1982. This national exposure continued with an FHA reverse mortgage insurance demonstration program being proposed by the U. S. Department of Housing and Urban Development. In 1984, the first open-ended risk-pooling reverse mortgage was offered and in 1985, HUD sponsored its first national conference on home equity conversion. In 1986, AARP established the "Home Equity Information Center" to provide retired seniors with information on this rapidly expanding home mortgage option.
In 1987 studies on home equity financing of long-term care were completed in Minnesota and Connecticut and the U. S. House Ways and Means Committee heard testimony on HEC and long-term care. In 1988, President Reagan signed FHA reverse mortgage insurance legislation and HUD created an HEC development team. 1989 saw the first line-of-credit reverse mortgage developed by the VA Housing Development Authority, followed by an announcement by Fannie Mae that it intended to purchase reverse mortgages insured by the FHA. That year, HUD selected fifty lenders by lottery to make the first FHA-insured reverse mortgages and released its "Home Equity Conversion Mortgage program handbook (#4235.1). Recognizing the need to educate counselors to assist the ever-growing senior population, multiple training sessions were conducted by both the AARP and HUD. Congress increased the FHA insurance authority to twenty-five thousand reverse mortgage loans by September 31, 1995 and the AARP published a "Model State Law on Reverse Mortgages. "Retirement Income on the House: Cashing In On Your Home with a Reverse Mortgage" was named the best book of 1992 on financial services for the elderly. By the end of 1993, the HECM program was in all states except AK, SD, and TX. In 1993, Congress enacted and the Federal Reserve published "Total Loan Cost Rate (TALC)" disclosure regulations for all reverse mortgages.
Throughout the 1990’s, AARP and HUD sponsored and funded education for consumers, financial planners, elder law attorneys and community counselors, creating a reverse mortgage counselor exam by 1999 which was co-sponsored by Fannie Mae and National Reverse Mortgage Loan Association (NRMLA). Ever on the watch for abuses, Fannie Mae announced new consumer protections in 1999 and AARP and NRMLA supported absolute limits on origination fees. In 2000, the first national, reverse mortgage counseling exam was taken by four hundred twenty-five counselors in forty-three states.
Under a reverse mortgage, the real estate to be mortgaged has already been purchased and any financial charges on title to it have been discharged. The borrower is not expected to make periodic payments, or any payments, until the loan comes due. For the lender, the value of the mortgaged property is paramount; for the borrower, the loan is obtained to supplement income or to enable purchases of assets other than the mortgaged property. Eligibility limits on reverse mortgages are much less stringent that traditional forward mortgages. Outside of homeownership, the borrower must be at least sixty-two years of age.
Given the importance of the value of the reverse mortgage borrower’s property, reverse mortgage lenders require that potential borrowers obtain an appraisal of their property. The potential borrower must pay for this appraisal. The cost of the appraisal should be borne in mind by borrowers; it will form a non-interest charge that should be factored into determining the overall cost of borrowing under a reverse mortgage. Some reverse mortgage lenders require borrowers to retain independent legal representation for the reverse mortgage transaction. Others require borrowers to provide a certificate of independent legal advice as one of the closing documents for the loan. Reverse mortgage lenders insist on having the first mortgage on title to the borrower’s property. If the borrower’s title is encumbered by other financial charges, then the borrower will be obliged to use part of the reverse mortgage proceeds, or other funds, to pay out and discharge these other charges.
Amount of the Loan
Lenders determine the principal amount of the loan by reference to the value of the house and the age of the borrower or borrowers. Older borrowers are usually entitled to a larger loan. Reverse mortgages have a lower initial loan-to-value ratio than conventional mortgages. The principal advanced tends to fall in a range between 10 percent to 40 percent of the value of the mortgaged property. Of course, as interest accrues over time, this ratio will become higher.
The interest component of reverse mortgages is usually pegged to an external rate. For example, one lender charges interest at a rate of 4.75 percent above the Libor Index, as it is set by the index from time to time. The lender "resets" its interest rate each year to account for variations in the underlying Libor rate. This method of calculating variable interest is not unique to reverse mortgages. A key feature of reverse mortgages that may escape some borrowers is that reverse mortgages are rising debt loans. Since borrowers are not making periodic payments they are not reducing the amount of interest accruing on the loan. As that interest is regularly compounded (usually semi-annually), the amount outstanding under the loan can grow to be quite large, as the borrower ends up paying interest on the accumulating interest.
Term of Loan and Repayment
Most reverse mortgage loans are not made for a set term of years. Instead, the reverse mortgage becomes fully due and payable on the occurrence of a specified event. That event is typically the earliest to occur of:
(1) A certain amount of days (for example, 120 days) after the date of the borrower’s death. (If there is more than one borrower, then this period begins to run after the date the last borrower dies.)
(2) The date on which ownership of the mortgaged property is transferred to another person. (A transfer can be a sale of the property, or another transaction, such as a gift, that vests ownership in someone other than the borrower.)
(3) The date on which the mortgaged property ceases to be the borrower’s principal residence. (Since it is often not a simple task to determine when a person’s principal residence changes, the reverse mortgage usually sets out a formula-such as three months continuous absence from the property-in order to determine when this event has occurred.)
Reverse mortgage lenders tend to look only to the mortgaged property for repayment. Many reverse mortgages limit the recourse that lenders have against borrowers personally. If the agreement provides for this, even if the amount of principal and interest outstanding at the time the reverse mortgage comes due exceeds the value of the mortgaged property, the reverse mortgage lender is not permitted to sue the borrowers personally for the balance. This nonrecourse feature of reverse mortgages effectively caps the amount that borrowers will be required to repay at the value of the mortgaged property.
Reverse mortgages, like mortgages generally, operate to secure repayment of a loan and performance of obligations by giving the lender enhanced rights if the borrower defaults. As is the case under a conventional mortgage, a default under a reverse mortgage leaves a borrower open to having his or her interest in the mortgaged property foreclosed. Reverse mortgages differ from conventional mortgages with respect to defaults in two main ways. First, the most common mortgage default is failure to make a periodic payment. Since reverse mortgage borrowers are not required to make periodic payments, as a practical matter they are less likely to default. This does not mean that defaults under a reverse mortgage are impossible. A borrower could fail to repay the loan when it comes due. In addition, a borrower who fails to make a property tax payment or a payment under a subordinate financial charge will, in all likelihood, find that such a failure constitutes a default under the reverse mortgage. Second, as noted above, reverse mortgages tend to be nonrecourse loans. In a true nonrecourse loan, the borrower has no personal liability to repay the loan or interest on it, and the lender’s remedies are confined to foreclosure or sale of the mortgaged property. Some reverse mortgage lenders operate on a true nonrecourse basis, and the mortgage limits their remedies for default to foreclosure. Other lenders provide that, while the original loan and interest on it are nonrecourse, the borrower will be personally liable for other types of charges. In addition, some reverse mortgages attempt to allow for changes in the value of real estate over time within a cap on the personal liability of a borrower. These lenders limit the borrower’s personal liability to the value of the mortgaged property at the time the reverse mortgage comes due, at the time it is sold, or at the time the reverse mortgage is actually paid, whichever is greatest. Since this conception of “value” could exceed the amount received from a sale of the mortgaged property, there is a possibility that a defaulting borrower could have to make up the difference personally.
IV. Statutory and Federal Regulations
The increasing popularity of reverse mortgages has state and federal agencies working diligently to keep reverse mortgages regulated. As is normally the case in lending, predators and abuses are plentiful, and seniors are among the nation’s most vulnerable population. State and Federal agencies offer consumer education and advocacy programs to help seniors protect themselves against reverse mortgage abuses. Most reverse mortgage literature explains that they are complex transactions requiring the assistance of a lawyer. All reverse mortgages require that the senior participate in counseling to assess whether an HECM is the right vehicle for the senior.
One such piece of protective legislation is the Consumer Credit Protection Act, which mandates that lenders disclose credit terms so that consumers can fairly and accurately assess whether a particular credit situation is right for them. The Truth in Lending Act was created in 1968 to provide consumers with an avenue to cancel a transaction without penalty upon determination that terms and costs were not adequately disclosed by the lending institution.
In 1975, The Federal Home Mortgage Disclosure Act was created in response to lending institutions contributing to the decline of certain geographic areas by their failure to provide adequate home financing to qualified applicants on reasonable terms and conditions. The Act was designed to provide the citizens and public officials of the United States with sufficient information to enable them to determine whether lending institutions were meeting their communities’ needs and to help public officials in their determination of the distribution of public sector investments in a manner designed to improve the private investment environment.
The Fair and Accurate Credit Transactions Act was originally created in 2003, and was amended in 2004 to add identity theft prevention, improve resolution of consumer disputes, improve the accuracy of consumer records, and to make improvements in the use of, and consumer access to, credit information.
Advances in state and federal oversight and regulation of reverse mortgages are ongoing, with the House passing (415-7) the Expanding American Homeownership Act (H.R. 5121) that made substantial improvements to the FHA Home Equity Conversion Mortgage (HECM), the nation’s most popular reverse mortgage program on July 25, 2006. A Senate version, S.3535, is also under consideration.
On a state-by-state basis, reverse mortgage legislation has been enacted throughout the U.S. Massachusetts passed its legislation in 1998 to define reverse mortgages and provide protections for the Commonwealth’s senior population.
Consumer Protections for Reverse Mortgagors
There are many protections in place for people who decide to take out a reverse mortgage. Federal Truth-in-Lending law requires that reverse mortgage lenders disclose the projected average annual cost of the loan. Borrowers can cancel the loan for any reason within three business days after closing. They must notify the lender in writing to terminate the reverse mortgage. Most lenders charge interest for a reverse mortgage at an adjustable rate on the loan balance. To protect borrowers, all reverse mortgage have limits on the rate at which interest costs for the loan can change within a year, as well as over the life of the loan. Changing interest rates do not affect the monthly payments that a borrower receives.
The costs that reverse mortgage borrowers pay are similar to those of a traditional home loan or to refinance an existing mortgage. These include an origination fee, appraisal fee, and third party closing costs (fees for services such as an appraisal, title search and insurance, surveys, inspections, recording fees, etc.). Most of these up front costs are regulated, and there are limits on the total fees that can be charged for a reverse mortgage. Since most of these costs can be financed as part of the loan, borrowers typically face few out-of-pocket costs for a reverse mortgage (typically the appraisal fee and credit check to make sure that the borrower is not delinquent on any other federally insured loans). All reverse mortgages are non-recourse loans, which mean that the borrower or heirs never owe more that the value of the home at the time of sale or repayment of the loan. This important feature is especially critical to surviving spouses who might otherwise be impoverished due to the cost of the loan. To receive this protection, HECM borrowers pay a mortgage insurance premium. Mortgage insurance offers additional security to both borrowers and lenders. Borrowers are protected against default by lenders. Lenders avoid losses that arise when the HECM loan balance exceeds the value of the home at the time of sale ("crossover risk".) FHA insures reverse mortgages issued under the HECM program.
Borrowers who apply for any reverse mortgage must first receive independent counseling before they complete the loan application. This helps ensure that borrowers understand the advantages and limitations of this type of loan, and are aware of possible alternatives to reverse mortgages. Counselors must work for a HUD-approved agency and receive special training on reverse mortgages. Currently, there are about 800 approved HECM counseling agencies who offer information and assistance to seniors over the phone or in person. The AARP Foundation has developed a national certification program for reverse mortgage counselors.
V. REVERSE MORTGAGE MYTHS & SCAMS
Despite increased popularity, even some of the most basic facts about reverse mortgages are often misunderstood. According to Peter Bell, the president of the National Reverse Mortgage Lenders Association, a relatively short industry history and rapid product evolution have deluged consumers with information that at times is confusing or inaccurate. “The most common misconception we hear is, ‘A reverse mortgage is where the bank gives you some money and then takes your house,'” says Bell. “That couldn’t be further from the truth. Our mission,” Bell explains, “is to inform seniors about the benefits of reverse mortgages so that they can make empowered decisions about whether this product makes sense for their own particular situation. A reverse mortgage helps people to address their retirement needs.” The organizations website lists the most common questions asked by consumers about reverse mortgages, with the answers. The questions are broken into three groups: those appropriate to ask before getting a reverse mortgage; those applicable during a reverse mortgage; and those applicable at the end of a reverse mortgage. This is the third guide published by NRMLA. The previous two are The NRMLA Consumer Guide to Reverse Mortgages, and Using Reverse Mortgages for Health Care: A NRMLA Guide for Consumers. The organization produces a detailed list of reverse mortgage products now available and a state-by-state list of reverse mortgage lenders who are members of NRMLA.
Using an online calculator to get a cash-out estimate for a Reverse Mortgage is actually a very simple process. Most Reverse Mortgage calculators only require that you input the current value of your home, the balance of your existing mortgage, and the ages of the borrowers. You will then be provided with a reasonably accurate estimate of the money you can receive. Many unscrupulous lenders are plugging in inaccurate interest rates in their online calculators causing inflated cash-out figures. Remember that the interest rate is the same no matter which lender a senior chooses. The advice is that seniors not shop for a lender based on the results of their online calculator. The Department of Urban Development actually dictates what interest rate all properly licensed Reverse Mortgage lenders must use, so the results should be virtually identical from all lenders.
Lenders MUST be Approved by the Government
All Reverse Mortgage lenders must be approved by the Department of Housing and Urban Development. Reports have been filed about companies claiming to have HUD approvals originating Reverse Mortgages and attempting to charge rates and fees in excess of those mandated by HUD. The HUD website contains a detailed list of approved lenders, to verify that a Reverse Mortgage lender is truly authorized to originate Reverse Mortgages.
The federally insured Home Equity Conversion Mortgage (HECM) does not have an equity sharing or shared-appreciation feature. Any increase in equity belongs to the homeowner and/or their heirs. Current advice is for seniors to stay away from anyone offering the senior the “opportunity” to obtain more money in exchange for giving up a percentage of the future value of the home.
V. Public Policy
The dramatically increasing numbers of seniors who may need financial support in excess of social security and other government programs require consideration of programs like reverse mortgages to support seniors. Indeed, data from HUD show that reverse mortgage use has increased substantially.
High levels of housing wealth among today’s seniors are a direct consequence of government policy to offer guaranteed home loans through the GI Bill and tax laws that allow mortgage interest deductions. Widespread availability of the thirty-year mortgage has also altered consumer attitudes toward debt. Even older Americans are now willing to refinance their homes and assume such lengthy mortgages. Having encouraged older Americans to accumulate over $2 trillion in housing wealth, is there now a need to create public policy that will encourage older homeowners to voluntarily tap home equity to pay for long-term care?
Promoting greater use of reverse mortgages for long-term care can be done incrementally, or as part of a larger effort to encourage seniors with resources to share more of the cost of Medicaid services. States could begin to encourage the use of reverse mortgages by addressing government regulations, along with program requirements and restrictions, that may present obstacles for impaired elders to “use their home to stay at home.” Eliminating such regulatory and eligibility barriers could unlock additional housing wealth by making the use of home equity more attractive to impaired, older homeowners.
Using a Reverse Mortgage to Stay at Home and Pay for Long-Term Care
Surveys have found that many Americans are inadequately prepared for long-term care needs. One of the most prevalent perceptions among Americans is that they will never need long-term care. Although, a recent survey found that sixty-one percent of people ages forty to seventy believe that their chances of needing long-term care are greater than being in an auto accident, most people remain unaware of the challenges of meeting this need.
Over half of senior respondents (fifty-nine percent) to a recent National Council on Aging survey, believe that they are likely to extremely likely to stay in their own home once they need help with everyday activities. Despite this optimism, many senior respondents (forty-three percent) had not made any financial plans to cover the cost of help they would need to stay at home. Responses offered as “financial planning” ranged from insurance to government assistance to help from family members. About one-quarter (twenty-seven percent) of adult children did not know if their parents had made financial plans for long-term care.
Reverse mortgages can provide a substantial amount of additional funds for a broad range of older homeowners. However, most elders are likely to be reluctant to tap home equity until they need assistance. In a recent National Council of Aging study, of the 13.2 million candidate households, about 9.8 million (74 percent) are dealing with some level of impairment that affects their ability to live at home (Table 3.3). Of these, 1.75 million (13 percent) contain one or more elders who have an immediate need for long-term care. These elders need assistance to perform one or more ADLs or IADLs. Among these households, almost one million are on Medicaid or at financial risk for needing government assistance to pay for long-term care. An additional 1.96 million households (15 percent) would likely require assistance in the near future because they only have difficulty with ADLs or IADLs. Nearly half of candidate households (6.1 million) are coping with functional limitations. These homeowners are an important target population for reverse mortgages because they are not well served by traditional sources of long-term care financing that target elders with a high level of impairment. Only the sickest seniors may be eligible to receive services through the Medicaid program. For example, beneficiaries receiving services under a Medicaid Home and Community Based Services Waiver (1915c) must be so severely impaired that they would otherwise require nursing home care before they can qualify for help at home. Similarly, long-term care insurance policyholders typically must need help with two or more ADLs to trigger their home care benefits. This makes it difficult for elders with limited financial resources and moderate levels of impairment to get timely help before they face a debilitating and costly crisis.
By liquidating their housing wealth through a reverse mortgage, the 9.8 million candidate households dealing with some level of impairment would be able to access $695 billion in total through HECM loans. The 1.75 million candidate homeowners with an immediate need for help with ADLs or IADLs could access about $121 billion in total from these loans. These financial resources could have a significant impact on the well-being of impaired elders and their families. By having money of their own to pay for long-term care, elders can maintain their dignity, as well as retain some independence and control over their lives. For spouses and other family caregivers, these supports can help reduce the financial, emotional, and physical strain that often comes with caring for an impaired elder (Family Caregiver Alliance 2003).
Reverse Mortgages and Public Assistance Programs
Many seniors appropriately question the impact of a reverse mortgage on their government entitlement programs: Social Security, Medicare, Supplemental Security Income or Medicaid benefits. Reverse mortgages do not affect Social Security or Medicare benefits because they are not based on the assets of the recipient. Federal SSI payments, however, require that beneficiaries keep their liquid resources under certain limits. Reverse mortgages offer the option of suspending payments if a senior is approaching the limit imposed by SSI guidelines.
Many states are creating legislation to assist seniors paying for home-care via reverse mortgages. These vary for state-administered programs such as Medicaid, Aid for Dependent Children (AFDC), and food stamps. The recommendation is that seniors consult local Council on Aging offices to determine how a reverse mortgage can impact local entitlements.
Reverse mortgages may be an appropriate tool for improved quality of life and as a replacement for dwindling government assistance programs for senior care. Multiple state and federal organizations and agencies have spent considerable time and resources exploring and regulating this income-generating tool. Demand for long-term care is growing in our rapidly aging society, placing an increasing burden on state Medicaid programs. As the second largest item in state budgets, Medicaid is already being targeted for cost control efforts. In this tight fiscal environment, home equity could play an important role in reducing government expenditures for long-term care. As with all services tailored to the senior population, continuing oversight and guidance is necessary to prevent abuses.