While Home Equity Conversion Mortgages (HECMs) have significant potential as financial tools for seniors who are trying to create cash flow in retirement, sometimes the benefits of HECMs can lead to a series of mistakes made by their borrowers. Access to an influx of cash can sometimes lead to irresponsible spending, with that cash chipped away and leaving little benefit for securing a senior’s retirement.
This is according to Jack Guttentag, aka the “Mortgage Professor,” in a new column published at Forbes. Not all of the mistakes that borrowers make are necessarily the fault of the borrowers themselves, however, since language explaining product benefits as circulated by different departments at the federal government can lead to missteps by HECM borrowers, he says.
The first mistake detailed in the piece revolves around the “lure” of getting an influx of cash upfront, Guttentag says. This can lead to diminished borrowing power over time, which could mean that the new source of cash can be exhausted more quickly.
“A large segment of HECM borrowers withdraw the maximum amount of cash possible at closing, which leaves them with no borrowing power for the future,” Guttentag writes. “While some seniors have compelling reasons for withdrawing the maximum amount of cash at the outset, many make a mistake in leaving nothing for the future.”
Late 2013 saw a rule change limiting upfront cash draws by the U.S. Department of Housing and Urban Development (HUD), which was fueled by concerns labelling HECMs as one source of losses to the Mutual Mortgage Insurance (MMI) Fund, Guttentag says. Borrowers who elected to take the maximum amount of cash often forgot to pay property taxes or homeowners insurance, he explains.
“Under the revised rules, borrowers could draw 60% of their available total at the outset and the remainder after one year,” Guttentag writes. “But this constituted a minor inconvenience to cash-hungry borrowers.”
Additionally, guidance published by HUD can actually be detrimental to a borrower’s full understanding of a HECM loan’s implications, Guttentag says.
“HUD provides no guidance to borrowers on how cash draws are used, with one exception: it warns them about the hazards of using their cash withdrawal to purchase an annuity,” he says. “The irony of this is that an annuity purchase is the only sure method of converting cash draws at origination into a flow of income over the borrower’s lifetime. An incidental effect would be a marked reduction in defaults that generate losses to the insurance reserve fund.”
Other problems borrowers may encounter include a “bias” against adjustable interest rates that have developed from prior experience with a forward mortgage; incentives for lenders have a chance to reinforce borrowers’ biases against the product category; there is a lack of good and predominant information about reverse mortgages for prospective borrowers; and HECMs are simply a complicated product category, he explains.
“Underlying the mistakes that seniors make is the complexity of HECMs and the fact that few seniors understand them,” Guttentag says. “While there is no way to make HECMs simpler, or to raise the IQs of senior borrowers, the likelihood of bad decisions can be reduced by improving the quality of advice that they receive, and the quality of the information to which they have access. I have attempted to play a role in that effort.”
Read the article at Forbes.