Times were tough for Dorothy Ariail back in 1977 when she became a young widow with three children. A schoolteacher on a tight budget, she put her children through college using a line of credit on her house in Charleston, S.C. Now she is an 80-year-old semi-retired grandmother with two sons and a daughter who are college-educated professionals—and she's still using real estate to manage her finances.
Mrs. Ariail owns several houses inherited over the years, and she has taken out a reverse mortgage on one of them. Her loan, a home equity conversion mortgage (HECM), is insured by the federal government and serviced by Generation Mortgage Co., the largest privately owned reverse mortgage retailer and wholesaler in the United States. Guggenheim Partners, a New York-based global financial services firm with more than $125 billion in assets under management, is Generation Mortgage's controlling shareholder.
"The little house I live in now became available right next to the house I had grown up in, so I decided that it would be nice to be near my children, and the reverse mortgage helped make that all possible," she says, adding that she rents out her other properties as retirement income while she waits for the housing sales market to improve.
While Dorothy Ariail is happy with her reverse mortgage, the product is often seen as an overpriced retirement income vehicle of last resort for distressed seniors. In fact, advisors typically avoid recommending them to their clients, and following Wells Fargo's and Bank of America's exit from the reverse mortgage market in 2011 due to worries about rising defaults, the product has come under an even greater cloud of suspicion.
"It would be a really rare circumstance where a reverse mortgage would fulfill a need for somebody. I've never done a reverse mortgage for a client for exactly that reason," says Susan John, chair of the National Association of Personal Financial Advisors. "There's always a better alternative."
Boomers and Big Business
Yet as the U.S. population ages in pricey properties they don't want to give up, the market for reverse mortgages is growing. In particular, HECMs have gained popularity because the federal government backs the program. As baby boomers age and home prices remain stagnant, seniors are likely to rely on them even more—and ask their financial advisors about reverse mortgages.
Here's the surprise for advisors who decide to give reverse mortgages a closer look: Under the right circumstances, there are times when the product may actually benefit a client.
"Given that many baby boomers will reach retirement with insufficient wealth from other sources, reverse mortgages are likely to become more popular," wrote the authors of a Boston College Center for Retirement Research white paper in 2006.
Five years and one Great Recession later, boomers are indeed asking about reverse mortgages. The number of HECMs has skyrocketed since 1989, when the Federal Housing Authority (FHA) started to approve this type of reverse mortgage. According to the National Reverse Mortgage Lenders Association, just 157 HECM loans were made in 1990, the first full year they were available, and the number grew year over year until it reached its peak of 114,692 in 2009. With the continued decline in the housing market, though, the number of loans fell to 79,106 in 2010, the last full fiscal year for which figures are available.
But according to advisors who have already done the research, HECM loans are the most viable reverse mortgages now available, and they are the only ones insured by the FHA. If anything threatens them now, it's not a lack of demand. It's the risk that the FHA will go broke and require a tax bailout for the first time in its 77-year history: Acting FHA Commissioner Carol Galante admitted in November 2011 that the FHA is facing "severe economic conditions," but asserted that the agency's programs are actuarially sound.
Available only to homeowners over the age of 62 with significant equity, HECMs are a special type of home loan that lets borrowers convert a portion of their home into cash. The property must be the borrower's primary residence, and the homeowner must have no delinquencies on federal debt. Once those restrictions are met, the advantage of a reverse mortgage is that borrowers can use their equity as cash while they stay in their homes. As the reverse mortgage pays out the equity in a home as cash, the homeowner's debt level rises and equity decreases, and repayment typically isn't due until the homeowner sells the property or dies.
Complications and Counseling
To be sure, the product is complicated, borrowers don't always understand the risks and HECM fees can be steep. Although federal law requires HECM borrowers to receive advice from FHA-funded housing counseling agencies, those services are not always the best. A 2009 report by the U.S. Government Accountability Office found inadequacies in the counseling process, citing instances where counselors failed to discuss other lower cost options available to borrowers and the financial implications of an HECM.
"HUD launched an initiative earlier this year aimed at improving the counseling services," Morningstar columnist Mark Miller wrote in an August 2011 column. "But more recently, Congress voted to eliminate funding that supported the counseling in a budget-cutting move, raising questions about how the program will be funded starting in October, when the government's new fiscal year begins."
Further, the AARP in March 2011 filed a lawsuit against HUD, charging that spouses of deceased HECM borrowers were not sufficiently warned that they were subject to foreclosure if they wanted to stay in the home but could not pay off the balance. In a second suit this year, AARP filed a class action lawsuit against Wells Fargo and Fannie Mae, challenging reverse mortgage foreclosures.
The good news, says Jeffrey Lewis, a senior managing director at Guggenheim Partners and the chairman of the board of Generation Mortgage, is the value proposition presented to consumers in terms of interest rates and how much is available.
"It is as good as it can be because there is no profit margin. It is the triumph of government intervention in a marketplace," Lewis says.
