Reverse Mortgages Ready for a Comeback Despite Risks

One expert calls them “an unfortunate late-life income vehicle.” They are as risky as the housing market. But reverse mortgages might be a boon to Boomers with little savings.

By Taylor Haney

This Gardena neighborhood has been Jack and Barbara Thompson's home for 54 years. A reverse mortgage helped them stay here. An audio slideshow tells their story below. (Taylor Haney)

Jack and Barbara Thompson found themselves running out of cash in the middle of their retirement. Jack had just turned 80 in 2007. Their monthly bills were ramping up, their credit card debt was pushing $80,000 and their cash was depleted.

“I don’t like to say hot water, but I guess it was hot water,” Barbara Thompson said.

They might have sold their four-bedroom home in Gardena and moved somewhere more modest, but they had more than finances to consider. Married in February 1960, they had bought their brand-new home a few months later on the GI Bill, and they had lived there continuously ever since. After 54 years, they loved their home too much to leave.

So they called a friend of a friend, Brad Dela Cruz, a Pacific Palisades-based advisor at the country’s largest reverse mortgage lender, American Advisors Group, or AAG. “And the proposition he gave to me was so sharp, and I said, ‘Oh my God. Sounds terrific,’” Jack said. In 2008, the Thompsons inked a reverse mortgage loan with Dela Cruz, allowing them to access part of their home equity and to stay put until they die, the Thompsons said.

Reverse mortgages are federally-backed loans designed for people like the Thompsons, seniors whose financial belts might have suddenly tightened, who need extra cash to keep up a certain standard of living, and who want to use money tied up in their home to fund their retirement. But they have a reputation of being historically risky. Reverse mortgages put the Federal Housing Administration in a $5 billion hole in 2013, requiring a taxpayer bailout of $1.8 billion, the first in FHA history.

Now, experts predict the reverse mortgage program, despite its image problem, will blossom in the coming years, with home prices stabilizing, with more Baby Boomers looking to retire. To capitalize on these trends, banks have been mounting aggressive ad campaigns.

Brad Dela Cruz, Senior Certified Advisor at AAG, set up the Thompsons’ reverse mortgage. He explained the reverse mortgage as “a program that allows a homeowner that’s over 62 to be able to convert a portion of their equity in their home into available cash.” That cash can translate into a line of credit, a lump sum, a limited term payment or a lower monthly lifetime payment. The borrowers still pay their property taxes and homeowner’s insurance while on the program.

While some say a reverse mortgage utilizes a home’s equity for a comfortable retirement, others see a program that drains a home’s equity—at the very time in life that being without the obligation of an overhanging debt is most important.

After the bailout of 2013, the Federal Housing Administration overhauled the reverse mortgage program. Potential borrowers “took a little bit of a haircut” on how much home equity they could tap into, Dela Cruz said. In other words, borrowers can no longer take out all their home’s available equity, all at once—a restriction meant to limit reckless spending or the “lottery effect.” The FHA made it harder to get a reverse mortgage and made it harder to qualify for as much cash as before.

So, in simple terms, how did Jack and Barbara Thompson get cash for their home without having to vacate it? Essentially they traded a portion of their home for about $300,000 plus fees and interest. They are allowed to live out their days as the nominal homeowners, because once they die or move, the bank will recoup that amount from the home, profiting from the interest and fees. The Thompsons have no monthly payments, but interest accumulates all the while. Their goddaughter, their sole heir, lives in Riverside. If she wants to sell the Thompsons’ house, she would collect whatever remains after the loan is settled. If she wants to keep the house, all that debt will become hers. Refinancing can be a thorny process for heirs, but for now the product provides a huge benefit for the Thompsons. It keeps them comfortably in their home.

“It’s a lifetime deal,” Jack Thompson said, “which makes it beautiful.”

But reverse mortgages are not entirely beautiful. They come with particular risks.

Unlike with a regular mortgage where the main risk is the borrower’s continuing ability to pay it off, a reverse mortgage’s risk is something much less predictable—the volatility of the housing market. The Thompsons’ home is worth $548,000, Barbara Thompson said. If that drops, and if its new value somehow does not cover the $300,000 plus interest and fees—which can add up quickly—the Thompsons' collateral would cover as much of the debt as possible. Part of it would be passed on to the Federal Housing Administration.

Raphael Bostic, a professor at the Price School of Public Policy at USC, recently finished a three-year stint working for the Department of Housing and Urban Development. He called reverse mortgages “a creative use of finance markets to provide a benefit for families,” which seniors had flocked to before 2007.

“Then,” he said, “the Great Recession happened.”

When housing values sank, a lot of reverse mortgages went under, enough to put a $5 billion dent in the FHA. This required the $1.8 billion bailout last year, although that “infusion” from the Treasury, as Bostic put it, was meant to fill up the FHA’s ample, mandatory cash reserves. “So it wasn’t as if the FHA was insolvent.”

When asked about the market for reverse mortgages locally, Bostic said Los Angeles residents may favor the reverse mortgage in the coming years, because home values have increased since the Great Recession. Moreover, Los Angeles is densely populated, so “the prospect of moving is not very exciting. So you would expect people here to be far more sensitive to the possibility of using a reverse mortgage, so they can stay in their home and live comfortably.”

Indeed, a recent Associated Press article placed Los Angeles second in the reverse mortgage market nationally, after Philadelphia.

This slideshow tells Jack and Barbara Thompson's reverse mortgage story. Jump back to the top by clicking here. (Taylor Haney)

Despite the popularity of reverse mortgages in Los Angeles, some are reluctant to recommend them. Some outright oppose them.

Gary Perez is President and CEO of USC Credit Union, a non-profit co-op that offers all kinds of mortgage products—except reverse mortgages. He has looked at reverse mortgages and debated whether to offer them “two or three times over the last 15 years.” Although they have a place, they do not belong at his credit union, he said. The fees for borrowers are too high.

“It’s just not something we felt we could responsibly offer at fees and charges that represent the credit union’s value pledge to its members,” he said.

When asked where reverse mortgages might belong, he said they do “serve a purpose for those seniors with few other options,” but that lenders offering these special loans have to be absolute experts “in this niche business.”

In other words, the lender needs to be able to present the whole picture. What will happen to the home if the borrowers have to move before they die? How are the property and loan passed to their heirs? And what happens when the housing market plummets again?

All of these questions need to be answered, so that banks can sell reverse mortgages “with eyes wide open, and limited to those that fully understand what the opportunities and the strengths are, both for them and their heirs,” Perez said. Unfortunately, reverse mortgages have a reputation for attracting lenders with unscrupulous practices. Even Brad Dela Cruz, the AAG advisor who set up Jack and Barbara Thompson with their reverse mortgage, said he sees “irresponsible lending” in his field. And plenty of lenders offer the product without knowing anything about it.

“They probably shouldn’t be offering them,” he said. “They just don’t have the accountability.”

And accountability is only the beginning of the common diatribes against reverse mortgages. Are they a good use of home equity in the first place?

Robert Bridges, Assistant Professor at USC’s Marshall School of Business, has serious doubts about the “bewildering number of federally [backed] programs” that offer incentives for investing in the home—reverse mortgages being one of them. Programs like these drive the cost of housing up, he said, ironically making it harder for many Americans to buy a home.

The fundamental question is whether reverse mortgages can ever be part of a wise investment plan, even as a loan of last resort. Bridges called them “an unfortunate late-life income vehicle,” when compared with any other investments like starting a business or creating a stock portfolio when a person is still young.

“The reverse mortgage is just one of the symptoms of a very widespread set of lending programs that are focusing on residential lending and making it easier for people to borrow money for houses, when they should perhaps be focusing on other things that are more important for their financial future.”

That applies to not only their own financial future, but also their heirs’ financial future. While some say a reverse mortgage utilizes a home’s equity for a comfortable retirement, others see a program that drains a home’s equity—at the very time in life that being without the obligation of an overhanging debt is most important.

“It’s not something certainly that I would advocate my mother do,” Bridges said.

The fact remains, however, that the enormous Baby Boomer generation has not prepared for retirement. Most of them have more money invested in their homes than in all their other assets combined. A reverse mortgage might be the only thing between some Boomers and bankruptcy.

When I asked them about the finer details of their plan, the Thompsons could not say much. Their reverse mortgage will allow them to stay in their home until they die. But what if they fall ill and need to move out? What if they can no longer live on their own? What would happen to their home then?

They did not know. “I hope we won’t have to go to the senior’s [residence],” Barbara Thompson said. “But if we have to, we have to. That’s life.”

Then she showed me around her home, telling me about every room, every picture and all the remodeling they had done recently. She diligently switched off the lights as we went from room to room. I asked her why.

“I got to turn the lights out,” she said. “I don’t want my equity to run out.”