Baby boomers are coming up short on retirement savings, but most of them have a key asset they bring to their later years: their homes.
Tapping that asset in the form of a reverse mortgage is becoming a popular way for seniors to generate income after they stop working, and reforms in recent years have reduced or eliminated many of the problems these loans presented in the past. While loan volume has declined slightly in recent months, seniors still have about 628,000 of the loans outstanding, roughly 1 percent of the overall mortgage market, according to the Consumer Financial Protection Bureau (CFPB).
But problems persist with reverse mortgages, not least in how the loans are advertised, and on Thursday the CFPB highlighted some of those shortcomings in a new study describing the results of a reverse mortgage focus group.
"The ads left the consumers believing that if they purchase a reverse mortgage loan, they will be able to rest assured that they can live in their homes and enjoy financial security for the rest of their lives," said CFPB Director Richard Cordray in prepared remarks. "Incomplete or inaccurate information in an ad can cause older Americans to make the wrong choice that jeopardizes their financial security. They could run out of money for their day-to-day expenses or they could even lose their homes."
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Tapping into home equity
Reverse mortgages enable seniors to use their homes to generate income and provide backup income when their investment portfolios dip. In a mirror image of a traditional mortgage, a lender in a reverse mortgage makes payments to the homeowner either as a lump sum, monthly payments or as a line of credit the homeowner may or may not use.
If homeowners maintain their homes and keep up with tax and insurance payments, they keep title to their home until they die or sell, and at that point the loan must be repaid, often with the proceeds of the home's sale.
"It can kind of replace a home equity line of credit," said John Salter, a wealth manager at Evensky & Katz/Foldes Financial Wealth Management and an associate professor of financial planning at Texas Tech University. Salter said he has put three clients in these loans: two because the lines of credit offered a backup in the event they needed them to supplement their savings, and one who refinanced the last of a traditional mortgage with a lower interest line of credit.
Nearly 76 percent of people aged 55 to 64 own their own homes, as do 79.5 percent of those over 65, so reverse mortgages are a potential lifesaver if those homeowners do not have much in the way of retirement savings. Millions do not: 58 percent of Americans aged 55 and over have less than $100,000 in total savings and investments, excluding their homes, according to the Employee Benefit Research Institute. (Tweet This)
"If households do not have enough from Social Security and their 401(k) assets, they should consider tapping their home equity by either downsizing or taking a reverse mortgage," wrote Alicia Munnell, director of the Center for Retirement Research at Boston College, in a report released in April.
Deceptive ads?
But the benefits of reverse mortgages only hold if borrowers truly understand what they are getting themselves into, and if the several dozen people in the CFPB focus group are an indication, many do not.
"Consumers found it difficult to understand from the ads that reverse mortgages are loans with fees and compounding interest. Most ads did not include interest rate information or included it only in the fine print," Cordray said in his statement. "Other consumers mistakenly thought that because the money they received through a reverse mortgage represented home equity they had accrued over time, there was no reason they would have to pay it back."
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That kind of misunderstanding can lead consumers to make any number of mistakes with these loans. If they take out a lump sum, they risk blowing the money and running short in later years. If they blithely take out the loan without having their spouse as a co-signer, and then die first, the spouse may be left trying to immediately repay the loan. (If both spouses sign the loan when they are 62 or older, the surviving spouse is allowed to stay in the house and repayment is deferred.)
Some of the ads for reverse mortgages feature celebrities, like former U.S. Sen. Fred Thompson and actor Henry Winkler. While the CFPB declined to cite specific ads with boldface names, Cordray said celebrity endorsements could be troublesome. One focus group member stated that "When it's a former congressman endorsing it, it makes it sound like a good idea."
Ads for reverse mortgages may be proliferating, but there are objective sources of information for seniors seeking to learn about reverse mortgages. For example, a CFPB fact sheet lays out how these loans work.
Homeowners can also seek out a financial professional to walk them through the reverse mortgage landscape, Salter said. And when looking for a lender, he suggested making sure they have no financial incentive to recommend a type of payment, such as a lump sum payout, that might not be in the homeowner's best interest.
"Find somebody that's willing to kindly explain everything from an educational perspective and ask if they are commission neutral," Salter said.