Reverse mortgage loans are generally a controversial topic and, like most financial products, their merit comes down to the specific terms. While any reverse mortgage should be evaluated based on its costs and its mortgage rate, there is one statistic that should be a warning sign to anyone considering one of these loans: According to the Consumer Financial Protection Bureau (CFPB), 9.4 percent of reverse mortgage loans are currently in default.
Why is this so disturbing?
That high default rate is disturbing for a number of reasons:
- Borrowers merely have to make their insurance and tax payments. Unlike conventional mortgage loans, reverse mortgages do not require monthly payments of interest and principal. So, the high default rate means that many reverse mortgage borrowers cannot meet the relatively small insurance and tax payments on their homes, even after borrowing against their equity.
- The default rate is rising quickly. That default rate jumped by an alarming 1.3 percent in less than a year, so the problem is growing quickly.
- Borrowers are taking the money earlier. While only people 62 and older qualify for reverse mortgages, the CFPB reports that once people become eligible, they are taking these loans out sooner than in the past, and are increasingly likely to take their loan proceeds in one lump sum upfront rather than via a series of structured payments. This increases the risk that retirees will burn through their assets early in retirement, leaving them without resources in later years.
- A new wave of eligible borrowers is coming. The leading edge of the baby boom just became eligible for reverse mortgages in 2008, meaning that the potential market for these products will continue to grow rapidly over the next several years. This means that problems with reverse mortgages are likely to grow.
The bottom line for borrowers
None of this means there is anything inherently wrong with reverse mortgages. However, the potential pitfalls suggest that borrowers should only choose a reverse mortgage if the following conditions are true:
- The loan is part of a long-term plan to meet expenses and stay in your current home.
- The mortgage rate and other expenses are competitive with other forms of financing.
- You fully understand the terms of the loan.
As with any financial decision, this last condition is the most important of all.