Part 6: State of the 'reverse' market
Part 6: State of the 'reverse' market
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.
All the suggestions about options involve lifestyle changes that the senior may not want. The fact is that for seniors who want to remain in their house and who want more spendable money, but don't want to give up their financial independence, there is no substitute for a reverse mortgage.
Seniors Use HECM Proceeds Unwisely: This is a major theme of horror stories about HECMs, most of which involve the purchase of annuities. In a recent speech, the Secretary of HUD recounted a case of an 88-year-old woman who used the proceeds of her HECM to purchase a deferred annuity that would not begin to pay off until she was 104.
Bad decisions of this type are encouraged by deceptive merchandising. While most merchandising merely plays up the benefits of HECMs and plays down the costs, some of it goes well beyond ordinary puffery. For example, in some cases, HECM borrowers are led to believe that they are required to purchase an annuity or an insurance policy.
The truth is that no one can require an HECM borrower to purchase insurance, an annuity or similar product as a condition of obtaining the HECM. Indeed, under legislation passed in 2008, HECM lenders are now prohibited from offering other financial or insurance products.
A critical line of defense against inappropriate uses of HECM proceeds is the legal requirement that every HECM borrower be counseled by an independent counselor with no connection to the lender. This has been part of the HECM program since its inception. When a senior purchases a financial product with HECM proceeds based on a belief that such purchase is required, the counseling process has failed.
In a recent study of HECM counseling, the Government Accounting Office (GAO) found that many counselors did not cover all the information HUD has on its checklist of "HECM Counseling Requirements." GAO's major policy recommendation was that HUD needed to improve its control procedures over the counseling process. It had very little to say about the content of the counseling requirements, which very clearly is deficient in correcting possible borrower misconceptions about annuities. Two of the seven questions on HUD's list deal with possible scams associated with estate planning services, but none deal with annuities.
The problem needs to be kept in perspective. From all indications, a very small minority of seniors is affected -- note the very high percentage of satisfied borrowers cited in my earlier article. While any number of abused seniors is too many, it is not an indictment of the program. Further, a modest addition to HUD's list of required counseling questions would cut the abuses even further. How about "Has anybody other than family and friends spoken to you about getting a HECM -- perhaps somebody who wants to sell you something?"
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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