By way of the Consumers Union report (“Examining Faulty Foundations in Today’s Reverse Mortgages”), I recently became aware of a groundbreaking study conducted by the University of Iowa in 2007. The study tested the cognitive decision-making abilities of older persons, and their conclusions strike at the very heart of reverse mortgages.

The researchers behind Orbitofrontal Cortex Real-World Decision Making, and Normal Aging began with the premise that natural aging processes significantly degrade the brain’s prefrontal cortex in a substantial portion of older people. The resulting neural dysfunction, they hypothesized, might explain why many older people engage in faulty decision-making, and appear to be particularly vulnerable to fraud.

The results were startling: “As many as 35 to 40 percent of elders they studied had flawed emotional responses that stem from abnormalities that develop in the brain’s prefrontal cortex. The study also determined that these flaws were leading the seniors to make financial decisions based in part on reward and ambiguity, which follow the same approach used by individuals with acquired prefrontal lesions (traumatic brain injury).” For example, the researchers observed that some of the participants were susceptible to the truth effect, whereby they were more easily persuaded by repeated information, regardless of merit.

Unfortunately, the onset of cognitive decline may coincide with a period of life in which many critical, long-term (financial) decisions need to made, related to “investment of savings and retirement income, purchase of insurance and living trusts, estate planning, and sudden changes in financial roles following the death of a spouse.” As if the constraints posed by limited finances, a lack of income, and general uncertainty about the future weren’t enough, it now turns out that many of these seniors might also lack the proper neurological capacity to make logical decisions on these matters.

If this is the case, then the reverse mortgage system in its current form is probably inadequate. For example, 90% of counseling sessions are conducted over the phone, where there is no way to certify the identity of the borrower, let alone his decision-making capacity. As if that weren’t enough, it seems that that most borrowers treat the counseling session as a mere formality. By the time they are required to complete it, they have already made the decision to obtain a reverse mortgage and are probably far along the process. Finally, due to the truth effect and related phenomena, seniors are probably more easily swayed by reverse mortgage marketing, which is full of rosy thinking misleading claims, and tend to play short shrift to downsides/pitfalls.

According to Consumers Union, there are a couple important implications. First, the guidelines for reverse mortgage should be strengthened with tighter, more balanced language requirements. Second, the counseling session needs to be modified, not only to protect borrowers from unscrupulous lenders, but in some cases, to protect them from their own shortcomings.