Credit Unions Beware: Reverse Mortgages Can Be Dangerous for You and Your Members

Joe Zampitella, Members Mortgage Company
June 23, 2008 | COMMENTS

They're back! The finance professionals who helped to create the subprime mortgage crisis are pushing reverse mortgages now instead. This is not good news. The reverse mortgage market has grown dramatically; originations of FHA-insured HECMs (home equity conversion mortgages) increased by nearly 27 percent last year. The Wall Street Journal reported recently that “only a year ago, homeowners interested in reverse mortgages had little to choose from beyond the plain vanilla government-backed products that long-dominated the market. Now, nearly a dozen large banks and mortgage lenders have launched reverse mortgage products . . . and half-a-dozen investment banks have started buying reverse mortgages, with plans eventually to package and sell them.” 

And why not? This is, after all, the same financing model that worked so well for subprime mortgages, as evidenced by the soaring foreclosure rates that are devastating homeowners and neighborhoods, the credit crunch that is squeezing businesses and consumers, the multi-billion-dollar losses rocking financial institutions and investors, and the looming recession that is attributed in no small part to continuing fallout from the subprime debacle. 

Even worse, according to other recent press reports, a significant percentage of the older borrowers obtaining reverse loans (you have to be at least 62 to qualify for most programs) are using the funds to pay off subprime loans. The brokers and lenders who ran over borrowers with a subprime truck are now backing up over them with a reverse mortgage tractor-trailer. And worst of all, they are inviting credit unions to hop aboard.  More about why the reverse-mortgage cowboys are trying to recruit credit unions later.  But first, what's so bad about these loans?

The Problems with Reverse Mortgages

There is probably no one better positioned to answer that question than Len Raymond, founder of H.O.M.E. (Home Owner Options for Massachusetts Elders) Program. Len pioneered the reverse mortgage model in Massachusetts more than 24 years ago and he's been fighting ever since to preserve the scope and consumer orientation of the original design. The idea, he explains, was to create a vehicle that would enable house-rich but cash-poor elders to remain in their homes as long as possible by tapping a portion of their home equity to finance essential living expenses—medical care, in-home assistance, utilities, and the like. As the name suggests, a reverse mortgage works in reverse. Instead of making payments on the loan, borrowers receive payments from it, either in a lump sum, scheduled or tenure payments, an equity line, or some combination of these options. Higher-than-normal interest (that's what satisfies the Wall Street companies) accrues and is compounded over the loan term; the loan is repaid, with accumulated interest, when the home is sold, which occurs, presumably, when the owner dies or chooses to live elsewhere. At least, that was the original idea.

The reverse mortgage model that Raymond envisioned, and that H.O.M.E. still promotes today, was structured to address defined needs and generally as a last resort for a small pool of older homeowners, who had no other viable financial options available to them. That bears little resemblance to the product that mortgage brokers and lenders are marketing aggressively today as a lifestyle option, desirable not just for a few financially strapped senior homeowners but for all seniors with equity in their homes (including, and especially, retiring baby boomers), and appropriate not just as a source of financing for essential expenses, but as a way to enjoy luxuries consumers could not otherwise afford, or as a source of funding for questionable investments, such as annuities, that consumers either shouldn't make at all, or should not be financing with their home equity. 

The morphing of the reverse mortgage from “last alternative for some” to “first choice for all” is just one of the problems Raymond cites on a long list of concerns that includes:

• The loans are expensive—much more costly than lines of credit or home equity loans, which are viable and preferable options for many of the borrowers who obtain reverse mortgages. The up-front fees, totaling thousands of dollars, and ongoing servicing costs typical of reverse mortgages can drain homeowner equity at warp speed, Raymond explains.
• The loans are complicated, which makes it easy to sell them to vulnerable elders, who don't always ask the right questions and don't understand the often incomplete and misleading answers they receive.
• Reverse mortgage borrowers often don't receive the comprehensive in-home counseling and resource planning assistance these loans require. While the federal (HECM) program “wisely” requires counseling for borrowers, Raymond says, if that counseling is provided over the phone, as is often the case, it is frequently generic and “incomplete,” failing to address the unique needs of individual borrowers. For example, Raymond notes, for low-income seniors, failure to manage the reverse mortgage proceeds carefully could affect their eligibility for some benefits, such as Medicaid. Pro-forma, long-distance counseling also sometimes glosses over or omits entirely a discussion of what Raymond terms “remainder life planning.” These long-term considerations are crucial for reverse mortgage borrowers, who must answer, but often don't ask, this bottom line question:  “Where will you go if you can no longer live independently, and what financial resources will you have available to finance those living costs if you no longer have equity in your home?”
• Reverse mortgages deplete equity. That's what they are designed to do, but this essential point is often downplayed or ignored in a sales pitch that emphasizes immediate cash payments with no cost to the borrower (“The loan pays you!”) and promises that owners can remain in their homes as long as they like. “The lender can't take your home as long as you are living in it.” 

An Empty Promise

That promise (“you can live here forever”) is probably one of the strongest selling points for reverse mortgages, but it also may be “a cruel representation,” Raymond points out. 

It's true that lenders can't demand repayment of the loan until the home is sold or vacated permanently, or the owner dies. But if all the convertible equity in the home has been tapped, the loan may not be large enough to cover unanticipated expenses or higher living costs for seniors in their outlying years. 

The assurance of life tenure won't mean much to someone who lacks the resources to continue living in the home and can no longer tap what should be their major asset (their equity) to finance a move to a nursing home, an assisted living facility, or other alternatives. Even the no-foreclosure promise can be misleading, Raymond points out, because failure to pay the homeowners' insurance or property tax bills would violate the mortgage note, providing grounds for the foreclosure that, reverse mortgage borrowers are assured, would never occur.

These aren't just theoretical problems; they are real-life scenarios Raymond encounters every day with seniors who obtained reverse mortgages they didn't understand and are dealing with consequences they didn't anticipate. (Remind you of anything you've heard about recently—the subprime mortgage fiasco, for example?) And the problems are only going to get worse, as the economy continues to weaken and as Wall Street portfolio managers, look to replace the above-market yields from subprime loans with above-market yields from reverse mortgages. The two products appeal to investors for similar reasons: The yields are higher than on traditional agency loans; the collateral is real estate; the investments are liquid (until the market collapses); and, in the case of reverse mortgages, thanks to federal insurance, the payments are guaranteed.  

They Want You!

It is easy to understand why the brokers and underwriters who were pushing subprime mortgages a few months ago are pushing reverse mortgages today—they need a new source of revenue now that the subprime market has collapsed, taking a large chunk of the economy with it. But why are they trying to enlist credit unions in this campaign? 

Wells Fargo, one of those erstwhile subprime lending giants, answered that question in a recent reverse mortgage pitch to credit unions, explaining with rare and probably unintended candor:  “As seniors, family members, and advisors become more familiar [with] and accepting [of] reverse mortgages, they will seek out companies that can trust.  By partnering with us, you can further expand your role as a valued and trusted resource.”

Translation: “We want to offer reverse mortgages through credit unions because your members trust you more than they trust us.” And with good reason. That's why Wells Fargo, Chase Manhattan, Washington Mutual, and a host of mortgage brokers are joining credit union trade associations and are racing to affiliate with credit unions—they're trying to wrap themselves and the reverse mortgages they're promoting in the cloak of credit union credibility, because they know borrowers are less likely to question these highly questionable loans if they come from credit unions the borrowers trust.

But here's a question you should ask: If reverse mortgages for some borrowers in some scenarios are, in effect, subprime mortgages in disguise (good for brokers and originators but devastating for borrowers), will the members who trust you today still trust you tomorrow? The brokers and lenders who want to be your reverse mortgage partners are asking you to put your credit union's hard-won credibility on the line in exchange for the opportunity to earn a point or two--$3,000 to $6,000 on the average $300,000 loan. Does that sound like a good deal or a fair exchange to you? Does it sound like a risk you should be willing to take?

And if reverse mortgage peddlers can comfortably pay you two points for doing little more than providing some basic information about your members (names, zip codes, home values, and outstanding liens), imagine what they are earning themselves from the up-front fees and ongoing charges on these loans. Doesn't that make you worry, just a little, about how onerous these loans can be for your older members? 

Look closely at the e-mail promotions that are flooding credit union in-boxes. They don't talk about the benefits of reverse mortgages for borrowers; they talk about an opportunity for credit unions “to create a new profit center;” they announce that “yield spread premiums are now paid” on FHA mortgages; and they promise expense-paid vacations to credit unions for simply referring qualified reverse mortgage borrowers, which sounds an awful lot like a RESPA violation to me. But regulatory concerns aside, any loan promoted based on the commissions it generates for originators is the last product a credit union ought to be offering its members. That's why credit unions said no to subprime mortgages, and you should say no to reverse mortgages for the same reason—because they aren't good for your members.

What Should Credit Unions Do?

How should you respond to the growing pressure on credit unions to jump on the reverse mortgage train? I'd suggest the following:

Educate yourselves about the product. When you understand how these loans, as originally conceived, are supposed to work and can work well for a few borrowers, you will also understand why the mass-marketed reverse mortgage doesn't work well for anyone except the brokers and lenders collecting huge fees from the loans they originate.

Consider the source of all the promotions inviting credit unions to offer reverse mortgages to their members. The lenders and brokers behind these invitations are presenting themselves as credit union affiliates, but that tells you only that they paid the dues required to join the organization. Membership in the League isn't a seal of approval; the League doesn't endorse affiliate members. It is probably safe to assume that mortgage folks who are talking to you about profit centers and yield spread premiums care little about the credit union philosophy and care a lot less than you about doing what's right for your members.

Consider the consequences if reverse mortgages create the pain for borrowers and the losses and negative publicity for lenders the subprime fiasco has generated. For a long time, Len Raymond has been a lone voice screaming about the dangers of reverse mortgages, but others are beginning to share his concern. The Senate Special Subcommittee on Aging held a hearing in Washington recently at which problems with the loans were highlighted. Even the AARP, which has done more than its share to promote reverse mortgages as a “lifestyle” product, has acknowledged that the “high costs and abusive marketing practices [associated with the loans] must be addressed.”

Help your members. Borrowers considering a reverse mortgage don't need a sales pitch, they need accurate information and objective advice, and they're not likely to get either from advisors who stand to earn thousands of dollars from closing a loan or from the financial “counselors” the brokers recommend. Credit union members ought to be able to get that advice—or suggestions about where to find it—from their credit union. They ought to be able to assume that the credit unions they trust will offer products they can trust. That's the credit unions difference.

Understand what is behind the push for reverse mortgages. It is greed, pure and simple — the same force responsible for the subprime boom and bust, with the same destructive potential. You've seen how the daisy chain of brokers, lenders, Wall Street money managers, and investors created one crisis. Don't let them use you to create another one.

Joe Zampitella is president of Members Mortgage Company in Woburn, Massachusetts. Contact him at 800-316-9790 or joe@membersmortgage.com.