Make no mistake; a reverse mortgage is a loan that over time could consume your entire equity. I call them the mortgages that keep on taking. Day by day, the borrower owes more money – not less. Start out with high fees and mortgage insurance added to the balance, and then compounded interest. By the time the senior is ready for the nursing home, there's no money left.
The New York Times' "Tapping Into Homes Can Be Pitfall for the Elderly" describes the high fees and potential unscrupulous behavior of those peddling reverse mortgages. At their best, reverse mortgages can be a very expensive annuity. At their worst, a financial advisor could funnel a lump-sum payout into a high fee investment or annuity. (It makes no sense to buy an annuity with proceeds when the reverse mortgage can be an annuity itself.) Other bad uses include emergency home repair or home improvements – onetime expenses.
Reverse mortgages allow seniors (62 and up) to start withdrawing equity from their home without actually selling their property. The seniors do not have to make any payments on their loans until they either sell or move out of their homes. In case of multiple borrowers (husband and wife), repayment is differed until they both leave. The property must be a primary residence maintained to HUD standards, and all property taxes and insurance must be kept current. Wells Fargo (NYSE:WFC) does not require the home be sold to satisfy the mortgage, just the loan be repaid.
The loan balance continues to grow while repayment is deferred, but the borrowers will never have to repay more than the value of their homes. Banks require this potential negative equity loss to be insured. Realty Times' " Are Reverse Mortgage Premiums Too High?" says that HUD insures 90% of reverse mortgages (Home Equity Conversion Mortgages – HECM). HUD charges 2% of the home's value (not loan amount) upfront and 0.5% of the loan balance each year. In addition, banks charge upfront fees of 2% or more on the home's value and annual servicing fees. Any previous mortgages must be paid off at settlement. Wells Fargo allows a partial lump-sum payout to cover previous mortgages on the property.
The five payout options quoted from HUD
- Tenure - equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
- Term - equal monthly payments for a fixed period of months selected.
- Line of Credit - unscheduled payments or in installments, at times and in amounts of borrower's choosing until the line of credit is exhausted.
- Modified Tenure - combination of line of credit with monthly payments for as long as the borrower remains in the home.
- Modified Term - combination of line of credit with monthly payments for a fixed period of months selected by the borrower.
Wells Fargo's reverse mortgages carry a variable interest rate, with the borrower choosing either monthly or annual adjustments. The interest rate adjustments do not change the payouts, only the rate of growth in the loan balance. Wells Fargo is very flexible in combining HUD payout options. (Other major banks did not provide any details on their websites.)
The Federal Trade Commission provides "Facts for Consumers" on reverse mortgages.
Disclosure: Author is long WFC.
