Reverse mortgage dangers debunked
Part 6: State of the 'reverse' market
By Jack Guttentag, Monday, February 1, 2010.Editor's note: This is Part 6 of a six-part series. Read Part 1, Part 2, Part 3, Part 4 and Part 5.
As pointed out last week, the growth of reverse mortgages has no resemblance to the growth of subprime mortgages, and there is no financial fiasco looming. This week I want to deal with three other arguments against reverse mortgages that keep popping up in the media.
Home Equity Conversion Mortgages (HECMs) Are Too Expensive: This argument is ubiquitous, yet it makes no sense. Too expensive relative to what? Right now, there are no private programs to compare HECMs with, but when such programs existed their costs were much the same. The instrument that most resembles the HECM is the forward home mortgage -- while they meet different needs, the delivery systems are very similar, the cost items are much the same, and therefore the total costs ought to be similar. And so they are, absent the mortgage insurance premium on HECMs.
About half the upfront cost of an HECM is the mortgage insurance premium, which is designed to cover losses to FHA over long periods. Whether the current premium turns out to be too large or too small remains to be seen. It is interesting that some of the people who complain about HECM expenses being too high also fear that FHA is facing a financial fiasco down the road, which if true would mean that the insurance premium is too low.
The cost burden of an HECM depends on how long the senior has the mortgage. That's why under Truth in Lending, HECM lenders must disclose a "Total Annual Loan Cost," or TALC, over periods of different length. TALC could have equally been termed the "Time Adjusted Loan Cost."
As an illustration, when I priced an HECM for myself, the lender disclosed a TALC on my transaction of 27.7 percent over two years, and 5 percent over eight years. Reverse mortgages are not designed to meet short-term cash needs.
Seniors Have Better Options: This is the major theme of an article by Alexandra Zendrian in Forbes called "Avoid Reverse Mortgages." And it is true that many, perhaps most seniors do have better options. I am a senior and I am not in the market for an HECM because I have better options. Under HUD rules, seniors who overlook relevant options are supposed to be reminded of them by their HECM counselor.
But some seniors don't have better options. They don't want to sell their house and move to a retirement village; they don't want to seek financial help from friends and family members; and they don't want a home equity loan that they will have to repay -- these suggestions all appear in the Zendrian article. ...CONTINUED
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Submitted by david rosenbaum on February 1, 2010 - 9:27am.
As you say, Jack, (i) the cost of HECM is not abusive, and (ii) the cost of a reverse mortgage is high at first and declines over time … i.e., the longer you enjoy access to the borrowed money, the cheaper your cost of funds! That is a very unmortgage-like fact.
Actually, that declining cost-curve is (uniquely) characteristic of a single premium annuity, which is effectively what a reverse mortgage amounts to in financial terms.
HECM is a mortgage only insofar as it entails a pledge of security in real property. What that pledge secures is access to a substantial amount of cash into the future -- a pretty decent general description of an annuity (and an utterly inaccurate description of a standard mortgage).
So, people might not get quite so worked up about the cost of HECM if they realized that cash-strapped seniors are not being gouged for a high rate of interest. They are paying a normal insurance premium for a product that only the wealthy can usually acquire -- an annuity.
It's a pretty good deal at the end of the day -- FOR THOSE WHO NEED IT AND UNDERSTAND IT. Again, this is your main point. For example, people who use HECM are (practically speaking) already paying for an annuity, and it will be the rare case when it makes sense for them to take the proceeds and buy another one! By the same token, people in very frail condition should be counseled to think hard before taking HECM. Early decedents/move-outs incur high costs, and it may appear that they have overpaid, though they simply lost an insurance/annuity bet. If you're pretty sure you may lose the bet, then look at other choices first.
One last point. The fact that FHA writes more than 95% of all reverse mortgages, and has done so year after year, tells us something. This is not a commercially profitable business! In fact, it is a government subsidized program and always has been. Senior homeowners aren't paying too much. By strictly market standards, they're paying too little, such that private companies by and large can't make a go of it.