March 24, 2003, Revised December 2, 2006, December 2, 2008

“I read a lot about reverse mortgages and how they are becoming part of the financial mainstream. Is this true, and if so, why?”

Reverse mortgages are picking up some steam, but they have a long way to go.

A reverse mortgage is a loan to an elderly homeowner on which the borrower’s debt rises over time, but which need not be repaid until the borrower dies, sells the house, or moves out permanently.

The “forward” mortgages that are used to purchase homes build equity – the value of the home less the mortgage balance. Borrowers pay down the balance over time, and by age 62, when they become eligible for a reverse mortgage, loan balances are either paid off or much reduced.

Reverse mortgages, in contrast, consume equity because loan balances rise over time. If there is a balance remaining on a forward mortgage at the time a reverse mortgage is taken out, it is paid off with an advance under the reverse mortgage.

The need for reverse mortgages has always been there. It is plausible to build equity during high-earning years, and consume it after retirement. It is even more plausible when other sources of retirement income aren’t enough to permit homeowners to maintain their lifestyle. It is most plausible when there isn’t enough income to even maintain their house and pay the taxes. Without reverse mortgages, the only way to consume equity is to sell the house and live elsewhere.

Yet reverse mortgages have always been a hard sell. In the 1970s and early 80s, I was personally involved in developing two reverse mortgage programs that offered excellent products. Neither program survived.

The major problem was not a lack of interest. Elderly homeowners with a need for extra money and no inclination to leave their houses to heirs invariably showed great interest. The problem was a lack of follow-through that resulted in transactions.

The decision was one on which it was very easy to procrastinate. Unlike taking a forward mortgage 30 to 40 years earlier, when the family needed a house to live in, there was no comparable pressure to execute a reverse mortgage. They had the house and the children were long gone, so a decision could be deferred indefinitely.

This tendency was strengthened by the fact that the decision involved their largest asset by far, which had emotional value beyond its financial value. Further, they were at a stage of life where they might not be able to recover from a serious mistake.

Caution and concern were heightened by stories about people like themselves who took out reverse mortgages and were later forced out of their homes. Several depository institutions offered deals to seniors that provided monthly loan advances over a set period, but did not guarantee lifetime occupancy. The deal was that the senior could remain in the house only so long as its value exceeded the accumulated debt. Since the debt tended to grow faster than the property value, eventually, if they lived long enough, they would be forced out of their homes.

The landscape began to change in 1988 with the development of a Federal program under the FHA called the Home Equity Conversion Mortgage (HECM). The borrower protections built into this program, along with the imprimatur of the Federal Government, paved the way toward increasing acceptance by elderly homeowners. The AARP also entered the picture as a major information source (see www.aarp.org/revmort).

HECMs account for about 95% of all reverse mortgages being written today. Other reverse mortgage programs are available from Fannie Mae, and from Financial Freedom Senior Funding Corporation, a subsidiary of Lehman Brothers Bank, FSB. In addition, some limited special purpose programs are available from some states and cities.

Under all the programs cited in the paragraph above, borrowers have the right to live in their house until they sell it, die, or move out permanently, regardless of how much their mortgage debt grows. If the debt comes to exceed the value of the property, the FHA or the lender takes the loss. In addition, loans under these programs are without recourse. This means that lenders cannot attach other assets of borrowers or their heirs in the event that the reverse mortgage debt comes to exceed the property value.

Reverse mortgage activity today has been growing every year. The number of new HECMs jumped from 7,781 in 2001 to 76,351 in 2006 to 112,154 in 2008 (years ending September 30). Still, this is a drop in the bucket when compared to the size of the potential market. Increasing numbers of seniors are realizing they can take reverse mortgages safely, but most still haven’t gotten the message. The mainstream stills lies ahead.