So, you’ve taken the plunge, and decided to borrow using a reverse mortgage. The next decision – and probably the most important one – is how you should receive disbursement of the funds that you are entitled to.

According to the Department of Housing and Urban Development (HUD), which regulates and insures reverse mortgages through the FHA, you have five options: Tenure, Term, Line of Credit, Modified Tenure, and Modified Term. All are generally calculated using actuarial assumptions (i.e. your age and the value of your home) and tweaked by an FHA mandated “multiplier,” based primarily, it seems, on the ever-changing financial situation of FHA – and not the borrower.

One that selects Tenure will receive “equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.” This is certainly the most conservative choice, and some would argue, the reason why reverse mortgages were created. With a tenure payment system, you can essentially turn the equity into your house into an annuity, to be paid out to you for as long as you live. [As a side-note, you would be well-advised to avoid buying annuities in conjunction with a reverse mortgage, since this adds another layer of administrative costs onto the mortgage, and will most likely be lower than the tenure payments. If the annuity provider advertises an annuity with better terms, he has probably made more aggressive actuarial assumptions, paid for with a reduced equity stake in your home].

Term represents a slight tweak on tenure, since it confers monthly payments for a fixed duration, rather than for the rest of the borrower’s life. Naturally, the advantage is a larger monthly payment than under the tenure system, since it can be calculated irrespective of the borrower’s age. The downside is that after the term expires, you could very well be left with little equity in your home. Another downside of both term and tenure payments is that they are not indexed to inflation, which means the money you receive now will be less in real terms than the monthly payment 10 years from now.

With a line of credit, you can access funds as needed. Some borrowers will withdraw all (or a large portion) of funds up-front immediately after obtaining the mortgage, in order to make repairs and/or modify the structure so that it is more conducive to being elderly. Withdrawing funds up-front for “frivolous” spending, is discouraged, even though your broker might dangle this as a benefit when trying to sell you on the mortgage. Using up your line of credit is akin to depleting the equity in your home, which is why the line-of credit is arguably the most dangerous option, when it comes to selecting a disbursement plan.

There are also two variations on the line of credit, known as modified term and modified tenure. As you probably guessed, these options blend the line of credit with term and tenure, respectively. Under both plans, naturally, the monthly payment that you otherwise would have received under a “pure” term or tenure is simply smaller, since some of the funds (with some input from you, of course), must be set aside for the line of credit. For those that want to withdraw a large chunk of money now for repairs/maintenance, will still retaining the security of a monthly payment, a modified term/tenure is probably the best bet.

There is no way to “beat” the system, since the funds available to you are calculated using the same set of assumptions, regardless of which payout system you select. From the lender’s perspective, you are entitled to all of the equity in your home, minus the upfront/administrative costs, accrued interest, and an allowance to mitigate against the possibility that the amount owed will ever exceed the value of the mortgage. This way, when the home is ultimately sold and/or the mortgage is repaid (whether the borrower is still alive or has already passed), there should be some leftover funds, which will be returned to the borrower or his heirs.

In some ways, I feel like my job as reverse mortgage reporter has been transformed into reporter on reverse mortgage reporting. In other words, there haven’t been too many noteworthy developments in the reverse mortgage industry in the last few months. A slight FHA rule change here. A clarification there. But nothing too substantive, or earth-shattering. This is to be expected, since the product is both relatively niche (only borrowers of a certain age are even eligible, for example) and reasonably straightforward. While the number of mortgage products was recently estimated at more than 1,500, the number of reverse mortgage products is basically 3 (not including private arrangements).

As I was saying, there isn’t much primary reporting for me to these days, only secondary reporting. Still, given that public and professional opinion on reverse mortgages seems to evolve daily, with two very different camps emerging. While there is less and less to be said about reverse mortgages themselves, then, but more and more to be said about what other people are saying about them.

Perhaps this year’s most widely-read report on the reverse mortgage industry was that released by the National Consumer Law Center, entitled “Subprime Revisited.” Since it’s release in October, the report has generated a tremendous amount of buzz for its unequivocal opposition to reverse mortgages, and has been seized upon by members from both sides of the divide for conflicting purposes.

Those looking to strengthen their cases against reverse mortgages have been quick to cite its profiles of borrowers that were blatantly scammed. There are stories of subprime brokers transitioning seamlessly into new jobs selling reverse mortgages, in the wake of the collapse of the housing bubble. These brokers are broadly accused of greasing their own commissions at the expense of borrowers, many of whom remain ill-informed, and are simply happy to receive a pile of money while retaining the right to continue living in their homes. Then there are reports of cross-selling, whereby borrowers are cajoled into buying annuities in conjunction with their reverse mortgages, which in one case yielded less than the interest rate on the reverse mortgage.

Those on the other side of the fence (the majority of which have a vested interest in selling reverse mortgages, it should be noted) have labeled the report a “one-sided editorial with a regulatory policy agenda built on generalizations and extrapolations.” They insist that on the contrary, reverse mortgages are easy to understand, and abuse remains the exception, as “brokers are decent, ethical professionals.” They point to high satisfaction rates and the lack of a major crisis as evidence that the reverse mortgage industry is fulfilling its fiduciary responsibilities to its customers.

As a rejoinder, I would argue that while scams and abuse are still relatively rare, they are on the rise, due to an in increase in the number of unaffiliated lenders (some of which are rightfully accused of employing sub-prime tactics to sell reverse mortgages). In addition, given that the FHA (which insures the majority of reverse mortgages) is on the verge of insolvency, it looks like a crisis is not far off. Finally, satisfaction rates remain high because the majority of borrowers only obtained their mortgages a few years ago. Thus, high satisfaction is to be expected, since these borrowers have only tasted the upside (“free” money) so far. When these loans start coming due en masse (due to borrower death, change of residence, bankruptcy), many of these borrowers will start crying foul and insist that in hindsight, they were duped.

Still, I think that it’s fair to say that the truth probably lies somewhere in between. Certainly, all mortgage brokers aren’t sleazy and all potential borrowers aren’t idiots. The incentives being the way they are, however, you can excuse people for being cynical about the motives of reverse mortgage lenders. On the other hand, with the recent enhancement in reverse mortgage counseling requirements, borrowers may have a more difficult time claiming that they were misled. Whether reverse mortgage mortgages are ultimately appropriate for the average eligible borrower is impossible to say; the best we can hope for is increased transparency and a lack of coercion.

Let’s face it; in a free society, the government (in this case, the FHA) can’t arbitrarily outlaw reverse mortgages because of a few bad apple lenders steering unsuspecting borrowers towards reverse mortgages even when not suitable. What the FHA can do, however, is increase the transparency of the process and the flow of information to potential borrowers, so that they can make informed decisions about the appropriateness of the product. Towards this end, the FHA is in the process of overhauling the system of reverse mortgage counseling.

It is already the case that every borrower must first complete a mandatory information session with an FHA-approved counselor. The problem was that many of these counselors were either disingenuous, uninformed, or downright dishonest. [Apparently, the FHA learned this the hard way through some undercover detective work, where counselors posing as potential borrowers discovered gaping holes in the counseling process]. The “problem” is that counseling is available either free of charge or at very low cost, which means that unscrupulous counselors must find another way to get paid. In many cases, counselors have provided referrals to reverse mortgage lenders, in exchange for a commission. While this is dishonest enough, perhaps it is worse that recommending a reverse mortgage lender carries the implicit belief that the reverse mortgage itself should be recommended.

The reformed counseling program, then will begin with a paring down of the list of approved counselors, so that these shills for the reverse mortgage industry can be weeded out. Those that remain on the list will then be required to pass an examination, demonstrating competent understanding of reverse mortgages. Furthermore, the protocol for the counseling session will be enhanced, and there will be a required list of items that must be covered. Opponents of reverse mortgages will be relieved to learn that one of these items is a summary of the alternatives to reverse mortgages. The counseling session will conclude with a brief “quiz” of potential borrowers. If the borrower can demonstrate a thorough understanding, then he will be presented with a certificate, which is necessary to obtain a reverse mortgage.

One of the potential downsides of the new FHA requirements is that they allow counseling sessions to be completed over the phone, where there is a possibility for misunderstanding and even impersonation by third parties which may wish to steer the borrower towards a reverse mortgage. While this could certainly increase convenience, it also could lead to abuse.

As a potential borrower, it is recommended that you complete the counseling session before you begin shopping for a reverse mortgage. The counseling session will not only provide insight into what you can expect from the application process and the types of questions you should ask, but also a list of approved lenders. To find an FHA-approved counselor, click here.

Traditionally, there were two lines of thinking regarding reverse mortgages. The first held that reverse mortgages should only be used by those in desperate financial circumstances, after most other options have been exhausted. The other camp insisted that reverse mortgages are perfectly appropriate for all borrowers, as long as they are of retirement age and have selected a reputable lender.

Now a school of thought has emerged that suggests reverse mortgages are rarely, if ever, appropriate for the majority of potential borrowers. Goes the argument- borrowers who feel compelled to turn to reverse mortgages for cash are necessarily house poor. That is, a disproportionate share of their spending goes towards their respective homes. This condition is actually exacerbated – rather than alleviated – by taking out a reverse mortgage, which gradually erodes the equity in one’s home, based on inherently unattractive terms.

Granted, this characterization is overly simplistic. The idea behind it, however is meaningful and straightforward. Reverse mortgages are structured to the benefit of the lender. They are marketed aggressively towards borrowers under the premise that the cash can be used for fun-filled spending sprees, rather than for emergency needs. The implicit assumption behind reverse mortgages is that it is necessary for you to stay in your home.

While borrowers can be excused for the sentimental desire to want to remain in their homes at all costs, for the vast majority, it’s neither practical nor economical. Borrowers that obtain reverse mortgages often fail to scrutinize the terms of the mortgages because the flow of cash is moving towards them. Whether or not they are receiving reasonable compensation for the equity in their homes is beside the point. Most people are just grateful to have the cash.

Instead, why not consider moving into a smaller house or into a retirement community. While even contemplating such a ghastly decision might be anathema to many borrowers, it is eminently reasonable. In this way, all of the accrued interest that otherwise would have otherwise inured to the lender (in the form of equity) can instead be used by you, at your discretion. In addition, if you still decide that you want/need a reverse mortgage, you can always obtain one on the new property. For those that advise against this on the grounds that you are selling into a weak market, consider how illogical this is, since you are simultaneously buying into a weak market. Sell for less, buy for less; it should work out to be a wash, regardless of home price levels.

In the end, the best advice I can offer is not a definitive ‘yay’ or ‘nay’ regarding reverse mortgages. The decision is ultimately yours, and yours alone. Just remember that alternatives exist, and that there is no such thing as a free lunch.

On November 18, 2009, the FHA published MORTGAGEE LETTER 2009-49, the purpose of which was to clarify “FHA requirements for secured subordinate financing under the Home Equity Conversion Mortgage (HECM) Program.” Specifically, the letter imparted that “there shall be no outstanding or unpaid obligations, either unsecured or secured, incurred by the HECM mortgagor in connection with the HECM transaction…”

This immediately sparked a raging debate in the reverse mortgage industry, where second liens had always been thought of as legal (if not uncommon) when subordinated under reverse mortgages. This debate has played out on the comments section of “Reverse Mortgage Daily,” where readers seem to have concluded that under no circumstances (except if used to make repairs, as stipulated in the FHA letter) can a second lien exist under a reverse mortgage.

Here, I’d like to offer my two cents. Let’s start with the basics: a second lien is basically another mortgage, that has lower priority than the primary mortgagee when it comes to being repaid by the borrower. This is especially relevant in the case of default, whereby the proceeds from the sale of the property would first be used to repay the primary mortgage holder before the second lien mortgage lender would receive anything.

The FHA has made it clear (on previous occasions, in fact) that it is forbidden for a borrower to take out a second lien in connection with a reverse mortgage. In other words, if the proceeds from the HECM reverse mortgage are not enough to pay the closing costs and/or repay any existing mortgage debt, the borrower is forbidden to take out a new (second lien) mortgage.

What’s less than clear is whether existing second liens are allowable. In other words, if the reverse mortgage proceeds were sufficient enough to repay an existing primary mortgage but not quite enough to cover a secondary mortgage, would the borrower still be allowed to obtain the reverse mortgage while continuing to service the existing secondary mortgage?

This uncertainty seems to be focused on a recent story that described precisely this kind of situation. The subject of the piece used the reverse mortgage to completely repay the primary mortgage but only partially repay an existing secondary mortgage. The folks over at Reverse Mortgage Daily have declared that “the subordination in the story by Mr. Kelly would be a violation of the mortgagee letter.”Personally, I’m not inclined to agree. The FHA’s letter forbids subordinated financing in connection with the HECM transaction. It doesn’t go so far as to say that subordinated financing is forbidden outright. Still, the letter is ambiguous, and we hope that the FHA will issue further clarification, so we don’t need to speculate further.

On a side note, subordinated financing (whether new or existing) is rare when the primary mortgage is a reverse mortgage. Since reverse mortgages are negatively amortizing (i.e. the loan value increases over time), there is a risk that the value of the mortgaged home could actually exceed the value of the mortgage. While lenders are protected against this possibility through the mandatory FHA insurance, a lender holding a second lien would have no protection against default, and thus would probably reject such an arrangement. In the case at the center of the RMD controversy, the reverse mortgage enabled the borrower to pay down half of the balance of the second lien. It is probably only because of this that the subordinate lender consented to a new primary mortgage.

The explosion in reverse mortgage lending has been accompanied by a proportional rise in unsavory activity. Smelling opportunity, scam artists have come out of the woodwork to perpetrate fraud, under the guise of selling reverse mortgages. As a (potential) reverse mortgage borrower, there are a few scams in particular that you should be on the lookout for, and a set of commonsense practices that you can follow to avoid becoming a victim.

Perhaps the most popular type of fraud involves overcharging borrowers. While ordinarily this would not be illegal (albeit dishonest), there are specific limits that apply to reverse mortgages. Depending on the size of the reverse mortgage, the fee should never exceed 5% (including a 2% origination fee, 2% insurance premium, and assorted other closing costs). If you are being charged more, there is a strong possibility that you are being deceived. The best way to protect yourself from being ripped off is simply to shop around. If a lender can see that you are comparing rates and scrutinizing prices, naturally he will be less likely to charge an extortionate price.

Skirting pre-loan counseling, the second type of fraud, is actually more of a prelude to fraud. Many lenders will downplay the importance of pre-loan counseling, even going so far as to recommend that borrowers skip it altogether. This constitutes outright fraud, since counseling by a certified organization is a legal prerequisite to receiving a reverse mortgage. The counseling session cannot be carried out by the lender itself, and phone counseling sessions are discouraged. If your lender tries to skirt the counseling session, there is a strong possibility that they have something to hide, and that he is trying to set you up to be defrauded. On a related note, such counseling is available free of charge. If your lender tries to exhort even one cent from the counseling session, you should consider him unscrupulous and try to find a new lender. If you have any doubts about the qualifications of your counselor (or even if you don’t), it wouldn’t hurt to select one from the List of FHA-Approved Counselors.

Then there is a category of scams which are blatantly dishonest, but sometimes difficult to discern. For example, there have been cases of middlemen and title agents that lied about maximum loan sizes, and pocketed the difference. Other instances involve these same dubious characters pocketing funds that borrowers have designated to pay down existing mortgage debt. Unfortunately, this type of fraud is very easy to perpetrate, since borrowers understand in advance that the bulk of the proceeds from the reverse mortgage will not be given to them, but rather to their primary mortgage lender. The best way to avoid becoming the victim of such forgery/theft is to choose a reputable lender, and to double-check with all parties to make sure that the correct dollar amounts of been transferred to the appropriate parties (including you, the borrower) upon completion of the reverse mortgage.

Other cases involve “false impersonation” that stems from the public misperception that reverse mortgages are directly arranged by the government. While the vast majority of reverse mortgages are indeed insured by the FHA (or Fannie/Freddie), they don’t play a role in the origination of mortgages. In short, don’t be fooled by a lender that claims to be working on behalf of the government.

The final category of scams is conducted with the complicity of the borrower. Under so-called “flipping” arrangements, “speculators purchase distressed properties and, with the aid of cosmetic repairs and inflated appraisals, deed them to seniors at above-market prices. Seniors—some of whom may be part of the scheme—typically are promised homes for no money down. In return, they secure a reverse mortgage and divert some, if not all, of the proceeds to the scheme’s promoters.” The best ways to avoid becoming ensnared in such a scheme is a) only secure a reverse mortgage on a property you already own, and b) seek (reverse mortgage) financing through a third-party lender, rather than through your agent, in the event that it is being for a new home.

Let’s face it: seniors make easy targets. The FBI agrees, noting that seniors are preyed upon because of the perception that they are trusting, naive, unwilling to report fraud, and have stable financial situations. For that reason, the FBI urges seniors to bear in mind the following when shopping for a reverse mortgage:

  • Do not respond to unsolicited advertisements.
  • Be suspicious of anyone claiming that you can own a home with no down payment.
  • Do not sign anything that you do not fully understand.
  • Do not accept payment from individuals for a home you did not purchase.
  • Seek out your own reverse mortgage counselor.

The reverse mortgage industry would have you believe that the credit crisis has not been kind. While there is probably some truth to this notion, as falling home valuations have made it difficult and unattractive for many borrowers to obtain reverse mortgages, it has actually increased the attractiveness for other borrowers. Out of crisis comes opportunity.

While the first generation of reverse mortgage borrowers was sold despite falling house prices, the next generation of borrowers is signing up because of low home home prices. That’s because for many borrowers, it’s no longer attractive to continue paying money towards a mortgage that is currently worth less than what it was initially appraised for. Such borrowers are choosing to instead cut their losses, and basically giving up what little equity many of them have left.

Newspapers are rife with reports of borrowers who have either failed to or opted against refinancing, and instead chose to simply take out a reverse mortgage on their home. Think about it: if you are at/near retirement age with less than 50% equity in your current home, why would you continue to make payments knowing that there is a good chance that you will never be able to pay off the loan?

Many borrowers are using this same calculus to guide their decision-making. Especially those borrowers whose primary mortgages are of adjustable-rate (ARM) variety. Many of these borrowers have faced higher interest payments over the last year, and are desperately working with their lenders to achieve some kind of loan modification. Failure to secure modification (and many times, even despite modification) often directly leads to foreclosure.

For borrowers who meet the equity, age, and other eligibility requirements, a reverse mortgage certainly looks like an attractive alternative. And in some sense, it certainly is. Just remember that there is no such thing as a free lunch. In signing a reverse mortgage contract, you have basically traded the right to continue living in your home free of charge (excluding insurance and taxes) in exchange for the gradual erosion of whatever equity you might happen to have left at the time of signing. Depending on how home prices behave over the next couple decades, you (or your heirs) could very well be left with nothing when it comes time to sell your home.

Before you rush to find a reverse mortgage lender, then, consider that there is still another alternative to a reverse mortgage and foreclosure: downsizing into a less expensive house. In this age of optimism and trading-up, that’s a tough pill for many borrowers to swallow. Besides, some homeowners might have sentimental reasons for wanting to stay in their current homes. Just allow me to reiterate: the price for this luxury – and it is a luxury – is steep. By simply moving into a smaller home, you could end up debt-free and owning 100% of your house. What could be better?!