Cautions for Seniors

by Peter G. Miller
July 10th, 2008

Mary Schapiro, the Chief Executive Officer, FINRA (the Financial Industry Regulatory Authority), spoke recently in Washington about tough times and financial choices:

“In tough financial times,” she said, “many investors feel pinched for cash—and some may search for different, often risky ways to make ends meet, or to maintain a certain lifestyle. Troubling trends include investors leveraging or prematurely depleting their retirement savings, trading in their insurance policies in transactions known as ‘life settlements,’ and tapping their home equity through reverse mortgages.”

Later she added these remarks regarding reverse mortgages:

“Reverse mortgages may benefit some senior investors by unlocking their home equity, but they should only be entered into carefully and with a complete understanding of the consequences.

“As we well know, the sting of the recent sub-prime mortgage crisis extends not only to Wall Street, but to Main Street as well. An estimated 2 million homeowners could face foreclosure this year, up from about 1.5 million last year.

“Borrowers who can no longer afford to pay their mortgages when the low teaser rates adjust to higher levels have limited choices: sell, refinance, seek a modification from the lender or face foreclosure.

“With negative equity, refinancing may not be an option; and in an area with depressed housing values and a glut of homes on the market, selling may not be possible.

“As a result, some homeowners who owe more on their mortgages than their house is worth are simply walking away, wreaking havoc on their credit profiles and their financial futures.

“For homeowners over the age of 60 who want to stay in their homes—and have equity in them—but are having trouble making their mortgage payments, a reverse mortgage might seem appealing.

“Like a home equity loan, a reverse mortgage allows a homeowner to convert home equity into cash that can be used for any purpose. Unlike other home loans, however, homeowners make no interest or principal payments during the life of loan. The interest is added to the principal, which is why reverse mortgages are often called “rising debt” loans.

“Yet, as more Americans near retirement age, some financial institutions are aggressively marketing reverse mortgages as an easy, cost-free way for retirees to finance lifestyles—or to pay for risky investments.

“Despite the fact that this product can jeopardize their financial futures, more and more people are buying them. Currently, the federal government insures about 350,000 reverse mortgage loans. Nearly one-third of these loans—about 107,000—occurred in 2007 alone. And two-thirds of these mortgages have been insured since 2005.

“Because home equity is often a homeowner’s most valuable asset—and the most precious source of retirement security—entering into a reverse mortgage is a very serious decision.

“Not only can they be costly, but just as in the case of life settlements, there may be serious unintended consequences if the homeowner doesn’t fully understand the terms of the transaction, including the possibility of becoming ineligible for Medicaid or other benefits.

“Moreover, since reverse mortgages typically come due when the homeowner moves for any reason—including going into a nursing home—some homeowners may be surprised to find that they have very little left over to pay for long-term care just when they need it most.

“The bottom line is that reverse mortgages are an expensive option that may prematurely deplete home equity that will likely be needed in the future.

“In an effort to help prevent investors from being harmed, FINRA’s enforcement and examinations departments are paying close attention to brokers who actually recommend that a homeowner use the proceeds from a reverse mortgage to invest in other financial products and potentially do further harm to their financial position.”

As I look at Ms. Shapiro’s speech I plainly agree that a home should not be financed or refinanced with a reverse mortgage to buy an annuity because the result is typically a huge loss for the homeowner.

That said, with regard to some of her other comments I am not certain that borrowers always have many options. If you need money TODAY then worrying about future issues such as Medicaid may not have much impact. Moreover, some homeowners are plainly using reverse mortgages to avoid foreclosure, a strategy which at least should be considered when other choices do not exist.

For Ms. Schapiro’s full remarks, please press here.

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