How Does A Reverse Mortgage Work And What Are The Pitfalls?
Added June 26, 2009 by Ilyce R. Glink
Summary: How does a reverse mortgage work? A homeowner can take out a loan based on the equity in their home, and the loan becomes due when the home is sold. Usually FHA’s home equity conversion mortgage (HECM) program is loaded with insurance to prevent any loss in case the value of the home drops. However, pitfalls with reverse mortgages can range from life expectancy issues to home value calculations. And any of these pitfalls can cause problems down the line with reverse mortgages.
Q: This comment is in regard to your recent column about reverse mortgages. You told your readers that they can take between 50 to 70 percent of their equity in cash from a mortgage lender and that the money doesn't need to be paid back.
It will become due when the seller leaves the home and the property will be sold. If the value of the home has gone down, the mortgage company will "eat" the loss. Not so.
HUD will pick up the difference between the original loan amount (the money given to the owners) plus the deferred interest which the owner didn't need to pay. Surely you must know that. HUD operates with taxpayers’ money.
So we're right back to where this mess started - fraudulent real estate practices by real estate mortgage companies who are subsidized by the taxpayers.
A: Thanks for your email. You’ve made several interesting and important points.
My understanding is that FHA’s home equity conversion mortgage (HECM) program is loaded with insurance to prevent what you describe from happening. At the moment, relatively few of these reverse mortgages are done each year (around 100,000 in total, compared to millions of refinancings and originations), and if any have gone upside down, it's a tiny number.
But in a recent trip to Washington, D.C. I spent some time discussing a possibly bigger issue, and that is how FHA’s HECM program calculates how much cash a homeowner can take out of a reverse mortgage.
Part of that calculation is based on age tables that may be out of date. People are living longer, and there is some concern that the age tables being used don’t reflect how much longer people are living.
Another area of concern is how fast the amortization tables used expects homes to appreciate. At the moment, the tables predict that homes will appreciate at 4 percent per year. Considering that home values are still falling, that’s wildly inaccurate. But even in more normal circumstances, expecting homes to appreciate at 4 percent seems a little too generous.
Finally, some reverse mortgage industry observers are worried that some seniors who are taking out these loans don’t fully understand them – or understand that they need to continue paying their real estate taxes and insurance. If there isn’t enough cash left in the reverse mortgage, and the senior stops paying the property tax bill and homeowners’ insurance premium, the house could be sold at auction. Then, everyone loses.
All of these scenarios can lead to big-time problems with the program, even with the hefty amount of insurance FHA currently collects on these loans. My sense, after speaking with several government officials and mortgage experts recently, is that the government is going to make some changes to the reverse mortgage program in order to ameliorate some of these possible risks.
My guess is that the amount charged for insurance, which is currently 0.5 percent, will rise. Stay tuned.
Read More about reverse mortgages and HECM:Reverse Mortgages Explained Can Reverse Mortgages Save Seniors Facing Foreclosure?
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