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A Troubling Housing Misstep By Boomers

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Who’s falling for reverse mortgages these days? Leading edge baby boomers, aged 62 to 64. They represent more than one out of five (21%) applicants, compared to only about 6% in that age group back in 1999, according to a new report by the MetLife Mature Market Institute. Almost half of applicants were under 70, double the percentage in that age group in 1999.

Is 62 too young to take out a reverse mortgage? “It spells trouble,” says Stephanie Moulton, an assistant public policy professor at Ohio State University and a former reverse mortgage counselor for AARP. If they don’t have other retirement assets and they’re spending down the equity in their house, these “young” reverse mortgage borrowers are putting themselves at great risk down the line.

The logic behind reverse mortgages is to allow older seniors to access equity in their homes so they can age in place. (You have to be at least 62). A lender advances money in monthly payments or as a lump sum, and the borrower remains on the hook for real estate taxes, homeowner’s insurance and upkeep. Meanwhile, the balance owed grows until the homeowner moves or dies and the house is sold.

The reality: there are rising defaults where homeowners can’t keep up with their property taxes. Or their health fails, and they have to move out. Poof! Oftentimes the homeowner ends up with no (or little) equity left, eaten up by accrued fees and interest that add up as you age.

Making matters worse is that many young borrowers are taking out reverse mortgages for the wrong reasons—not to live out their final year in comfort in their family home but because they need cash, now, to cover short-term financial shortfalls, according to the MetLife report, Changing Attitudes, Changing Motives.  (Wells Fargo and Bank of America quit offering reverse mortgages last year, leaving MetLife as the biggest player; 74,000 of these loans were made last year, down from a high of 115,000 in 2009.)

The report subtly sounds an alarm to all prospective borrowers: “To the extent that they decide to tap home equity today, this resource will not be available to meet future needs. The decision that these aging homeowners make will therefore have long-term consequences for their retirement security.” And a more direct warning targeted toward big spenders who are saddled with debt: “These homeowners might be better served if they resolved their financial problems now, rather than deferring them through a reverse mortgage loan with interest to the future.”

Another factor hurting the young borrower is the higher relative cost of these loans at younger ages. Borrowers of all ages pay the same upfront fees and costs, but older borrowers get more money (because their life expectancy is shorter). The report gives this example where both borrowers pay $15,000 in upfront fees: A 65-year-old with a $250,000 paid up home could expect to get $103,000 as a lump sum or $687 a month for as long as she lives in her current home with a standard reverse mortgage. In contrast, an 85-year-old with a $250,000 paid up home would get $141,000 as a lump sum or almost twice as much per month.

Reverse mortgages are so complicated that would-be borrowers have to go through counseling (mandated by Congress) before hocking their house. The counseling rules were expanded in 2010 to include what’s called a FIT assessment. In addition to describing the loan options, the counselor discusses whether the loan is right for you based on personal issues such as your health, your plans to leave your house to heirs, and how long you plan to live there. Ideally you’re healthy and can stay in your home forever. But most reverse mortgages have short life spans, Moulton says. The average reverse mortgage survival rate is 7 years, and it’s only 22% that make it to 10 years.

So what happens to borrowers after they leave their homes? That’s one of the questions Moulton hopes to answer in a three-year research project she’s undertaking (funded by the MacArthur Foundation) to look at what impact reverse mortgages have had on the long-term financial well being of a subset of 30,000 borrowers who got counseling from Atlanta-based CredAbility. “Where are these people now? We don’t know,” asks Moulton. Her top concern is for seniors who are entering retirement without any or very little retirement savings. She notes that according to the 2007 Survey of Consumer Finance, home equity represents 80% of total wealth for one quarter of senior homeowners over the age of 62. They need to use that housing wealth wisely.

For folks with substantial retirement savings beyond their housing wealth, a reverse mortgage could be part of an overall retirement income strategy—even at the young age of 62. In an article in the Journal of Financial Planning,  Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income, authors tax lawyer Barry Sacks and economist Stephen Sacks show that for these homeowners a strategy of drawing on a reverse mortgage credit line at the outset of retirement—instead of using a reverse mortgage as a last resort after exhausting other assets--increases the likely duration of their cash flow in retirement and their total retirement income withdrawals.

One last word: The U.S. Dept. of Housing and Urban Development warns prospective reverse mortgage borrowers: “beware of scam artists that charge thousands of dollars for information that is free from HUD."