The Reverse Mortgage Risks Every Retiree Should Know

Reverse mortgages can be a productive use of home equity for many American households, but no retirement strategy is perfect for everyone and there are some risks retirees should understand before getting a Home Equity Conversion Mortgage (HECM), suggests one fee-only financial planner in a recent blog post.

Dirk Cotton, who has researched and published papers on retirement finance and regularly covers reverse mortgages on his blog The Retirement Cafe, looks at the possible HECM risks for retirees through the viewpoint of a more complex perspective that goes beyond simply providing a list of reverse mortgage “cons.”

Rather, Cotton tackles the subject within the context of retirement planning and the circumstances that could pose risks for retirees, given their financial situation and obligations as a HECM borrower.

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One possible risk he mentions is that a HECM does not guarantee retirees can keep their home.

“A HECM guarantees that you can keep your home for as long as you, a spouse or a non-borrowing spouse still live in it,” he writes. “It also guarantees that you can’t owe more when you repay the loan than could be recovered by you selling the home at fair market value.”

While HECMs provide the opportunity for borrowers, their estate or even their heirs, to pay off the loan with other assets and keep the home, Cotton writes, they do not guarantee that the borrowers will have the financial means to do so.

Another potential risk Cotton relays is that a forced repayment can happen at the “worst possible time.” Repayment of a HECM typically occurs when the borrower dies, moves from the home or can no longer afford the cost of the home.

In a previous work, Cotton explained that elder bankruptcies are usually the result of expense shocks rather than poor investment results. Unexpected and interconnected events, such as the loss of a job or the incurrence sizable medical costs, only make matters worse for a retiree and can have an adverse affect on their HECM borrowing.

“If those interconnected problems also result in a HECM borrower needing to move out of an expensive home to stabilize her finances, her HECM will need to be paid back at the worst possible time—during an ongoing financial crisis—and may accelerate the downward spiral,” he writes.

Cotton acknowledges that it is also possible that a HECM might stabilize the downward spiral and save the retiree’s finances. But when credit is not adequate, however, the forced repayment could accelerate the spiral.

Read the rest of Cotton’s reverse mortgage risks at The Retirement Cafe here.

Written by Jason Oliva

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  • Mr. Cotton provides examples or scenarios which are very relevant since a HECMs is not a cure all. It is odd that financial advisors never discuss risks of taking HECMs and risk tolerance in the context of getting a HECM.

    The point is risk is relevant and the risk tolerance of a prospect should never be ignored if the originator wants to take the position that he is acting in a manner that puts the prospect first. Rather than countering risk concerns with rehearsed answers, perhaps the best thing to do is to stop, listen to the client, and let them weigh the pros and cons of getting the HECM.

    For example, a woman living in a mountain resort community was looking at stopping her mortgage payments by getting a HECM. She had one goal and that was to have sufficient wealth so that at the time she was no longer physically able to live in that community because of the rigors of winter, she could live in a religious senior community that was subsidized by the religious organization but the buy in was not.

    As this senior thought through her situation, her risk tolerance caused her to delay her decision for months. We did not push this woman but waited on her decision. She got the HECM. The year was 2005. In 2009 she decided that the joy of life in the mountains was less rewarding than in the past and wanted to make her move. By then her home value was down by 55%. The buy in in the religious community was down 35% but with selling costs, she no longer had the net assets she needed to make the move.

    To this day we are grateful we did not play the “overcoming her objections” game. To this day even though she regrets getting the HECM, she understands her decision was her own. She made the gamble, no one forced it on her.

    On another occasion I was dinning at the home of an originator when THE call came in from a borrower who had been “convinced” by this originator that a HECM would take care of her immediate and long-term needs. Now she was in default for failure to pay her property charges with no money left out of her “really large sum lump payout” from closing. She had been afraid that the circumstances she was now in would be the result of getting a HECM but her objections and concerns had been “overcome.”

  • Mr. Cotton’s article was relevant in many ways as Jim Veale points out in his comment. I agree, the reverse mortgage is not the perfect solution for everyone.

    One area Mr. Cotton is wrong on is where he referrers to the borrowers heirs. He states. you can’t pass on the home to heirs. It must be sold by your estate to pay back the loan! Not in all cases, the heirs can keep the home and pay it off with their own funds, the heirs can sell the home if they feel their is enough equity to make it worth wild. Or they can just let the lender take back the home, their choice!

    The heirs are under no obligation to do anything, if they so desire! There are other areas that could be pointed out his article as well.

    One are of my friend Jim Veale points out about the woman living in a mountain resort community, this was an unfortunate experience she had. However, no one can predict the market or the economic unexpected and uncertain changes these days!

    In any event, the article by Mr. Cotton was decent but I am sure we are all aware that the borrowers interests come first and our job is to make sure we are doing the right thing for our seniors by placing them in a reverse mortgage in the first place!

    John A. Smaldone
    http://www.hanover-financial.com

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