By: Dan Kadlec
July 3, 2012
When did the American Dream turn into a cash machine? Home ownership has long been a source of pride and a symbol of achievement. In recent years, though, it's taken on a more utilitarian role: retirement backstop.
Nothing has been more instrumental in this transformation than the reverse mortgage, a clever bit of financial engineering that came on the scene in 1988. Through a reverse mortgage, under-saved retirees can essentially take out a loan out against the equity in their home, and can even turn the proceeds into a monthly income stream. In some ways it's a brilliant idea, allowing Americans past the age of 62 to extract cash from what is likely their most valuable asset - without having to move.
Yet the trend is troublesome. The home used to be a safety net, an asset that was there if all else failed and that provided some assurance that you would leave a financial legacy. Today, it's become just another source of funds to draw upon in your later years--like an IRA or an annuity. It would be bad enough if all this meant was that you were wiping out your safety net. But it's much worse.
The reverse mortgage is broadly misunderstood, according to a report issued last week by the Consumer Financial Protection Bureau. For income-starved retirees with home equity, the wisest use of a reverse mortgage is turning a home into annuity-like guaranteed monthly income. Yet a startling 73% of reverse mortgages last year were taken as a lump sum--up from 43% three years earlier.
Much of this cash-out was used to pay off other debts, which means the homeowners who took out these reverse mortgage are likely to have exhausted much of their home equity. Their safety net is gone and they have nothing in the bank and no income stream to show for it. Another startling number: 9.4% of those who took a reverse mortgage have fallen behind on their property tax and insurance, putting them at risk of being kicked out of their house.
We're way past the wild-west early years of the reverse mortgage, when fees were high and sales people often unscrupulous. Today's reverse mortgages have fewer up-front costs and are a better deal for consumers--so much so that big players like MetLife, Bank of America and Wells Fargo have found the business to be unprofitable and gotten out of the business.
Still, many who take out a reverse mortgage do not even understand that they are borrowing money and that they can lose their homes if they do not stay current on upkeep, taxes and insurance. "The rising balance, falling equity nature of reverse mortgages is particularly difficult for consumers to grasp," the CFPB reports.
But the bigger concern may be that reverse mortgages have become so mainstream that homeowners fail to consider other and often-better options--like looking first to generate income by annuitizing assets in a 401(k) or IRA; selling the house outright and downsizing; or, with rates so low, doing a traditional cash-out refinancing.
The reverse mortgage is here to stay. Last year, some 72,000 reverse mortgage loans were issued. It's a great fall-back for retirees that have run out of options. But it's a little unnerving that so many folks now plan to draw down their home equity as if it were just another savings account -- in effect, to sell their dream for cash.