Reverse mortgages: predatory lending or valuable planning tool?

By Andrew Zashin*

This article originally appeared as a column for the Cleveland Jewish News.

“Are you over the age of 62?”

“Do you have equity trapped in your home?”

“Having trouble making your monthly mortgage payments?”

“Supplement your retirement savings and make that money work for you.”

Targeted advertisements tout the benefits of reverse mortgages.

A reverse mortgage is a special type of loan offered to homeowners over the age of 62, generally with at least 50 percent equity in their home. Under this type of loan, borrowers pay property taxes and homeowner’s insurance, but no mortgage payment, and get immediate access to the home equity that has built up. The borrower keeps the home and will generally never be forced out of it.

It differs from other loan products like home equity loans or home equity lines of credit in that the borrower makes no monthly mortgage payment. Instead, repayment of the loan – including the interest that has compounded each month – is deferred until the home is sold or the borrower dies.

In general, the home is the collateral for the loan, and the borrower, or borrower’s estate, is not responsible for repaying interest that exceeds the home’s value. Given the way these loans are structured, it should come as no surprise that there may or may not be any equity left in the home when it is time to sell it.

This type of loan – known more formally as a home equity conversion mortgage – was first made available under the Reagan administration in 1988. In the subsequent decades, reverse mortgages have been criticized for many reasons, including confusing terms that make predatory lending a concern, high initiation costs, higher interest rates than conventional mortgages or home-equity loans, and compounding interest that can quickly deplete home equity, leaving little wealth to pass on to heirs.

AARP has been rather vocal in its efforts to advocate and educate consumers about this planning tool. While the terms of a reverse mortgage prevent foreclosure on the borrower, before 2014 those protections did not extend to a surviving spouse who was under the age of 62. The law was subsequently changed, making it a less risky option for borrowers with spouses below the age limit.

Reverse mortgages have developed a stigma as being a “last-resort” option for those who desperately need money because they have insufficient retirement savings to meet expenses or unexpected bills. It is certainly true that this type of loan can help with those things. But the recent recession is still fresh in everyone’s mind and has proven that real estate is not the sound, guaranteed return investment that it was historically thought to be. While this loan product can certainly help people with cash flow concerns, even if you have more than enough saved to last and sustain a few retirements, rising home values may make a reverse mortgage a smart financial tool to – just like advertisements say – make your money work for you.