Sandwich Generation: Advice on Reverse Mortgages

Jeff Brown writes a biweekly blog about the Sandwich Generation and the financial issues its members face as they try to help their parents and their adult children. The blog appears on Next Avenue and on the website of the public television show Nightly Business Report. A highly respected financial journalist, Brown brings personal expertise to the subject because he is part of the Sandwich Generation.
 
A number of years ago, my mother helped an 80-something friend get a reverse mortgage on a modest home an hour north of New York City. After a lifetime of cleaning houses, our friend had no savings and the income from the reverse mortgage allowed her to live decently in her last five or six years. (A reverse mortgage is a government-backed loan for homeowners 62 and older taken out against the home’s equity — the property’s value minus the balance on any mortgage or home equity loan.)
 
Reverse Mortgage TV Pitches and Reality
 
But the reverse mortgage didn’t have the rosy outcome described by those TV pitchmen. Our friend’s son was furious. He’d seen the family home as an asset for his retirement. Worries about his future — and his ill will — marred his mother’s last few years.
 
(MORE: How to Use Your Home to Stay at Home)
 
So there you have it in a nutshell: A reverse mortgage can be a lifesaver, but its ever-growing debt can turn the loan into a loser by devouring the home’s equity and leaving little or nothing for the borrower’s heirs.
 
That’s why when the financial interests of two, three or four generations are intermingled, as they are for Sandwich Generation families, the benefits of reverse mortgages need to be carefully weighed against alternatives, like selling the home.
 
As the Consumer Financial Protection Bureau recently warned in a report to Congress: “Reverse mortgages are inherently complicated products that are not easy for the average consumer to understand.” And The New York Times just noted that some lenders are aggressively pitching reverse mortgages to older Americans who can’t afford them.
 
Reverse Mortgage Basics
 
The basics of a reverse mortgage: There are no monthly payments, but the accumulated debt and interest charges must be paid after the owner moves, sells the home or dies. (The homeowner can’t be forced to sell or move as long as he or she keeps up with the payments for property taxes, homeowners insurance and maintenance.) While a normal mortgage's balance gets smaller as the years go by, it gets bigger on a reverse mortgage as the unpaid interest obligation builds up. And the fees for getting a reverse mortgage can be steep. The most common reverse mortgage is the Home Equity Conversion Loan, backed by the U.S. Department of Housing and Urban Development.
 
Here’s an example: A homeowner who borrowed about $55,000 with a reverse mortgage could pay nearly $7,000 in fees to open the account and would have a loan balance of $86,000 after five years, $112,000 after 10.
 
Because there are no monthly payments with a reverse mortgage, the homeowner doesn’t need an income to qualify, the way he or she would for a traditional mortgage. That’s what makes these loans especially appealing to retirees.
 
To reduce the odds that the home won’t sell for enough to cover the debt, reverse mortgage lenders limit the size of the loans.

A 62-year old can borrow only about 50 percent of the home’s equity. Older homeowners can borrow more — as much as 77 percent of the equity for an 80-something — because there’s less risk the debt will outgrow the home’s value given the older borrower’s shorter life expectancy. (The online Ibis reverse mortgage calculator gives you an idea of how much you could borrow.)
 
When to Consider a Reverse Mortgage
 
Because of these loan limits, most experts say a reverse mortgage is best left as the last asset to tap in retirement. In other words, wait to get one until you’re in your 80s rather than when you're in your 60s, since there’ll be less time for the snowballing interest obligations to chew up the home’s equity.
 
For a Sandwich Generation family, this generally means a reverse mortgage is an option for the oldest generation, not their 60- or 70-something children.
 
Risks of Lump Sum Payments
 
Consumer advocates also caution against taking a reverse mortgage as a lump sum.
 
Jack M. Guttentag, an emeritus professor of real estate at the Wharton School, says some lenders have pushed homeowners to receive their reverse mortgages this way, because they’re more profitable for the financial institutions. In 2011, about 73 percent of reverse mortgage borrowers took all or nearly all of their available equity up front, according to the Consumer Financial Protection Bureau.
 
(MORE: Checklist for Helping Parents With Finances)
 
But taking the reverse mortgage as a line of credit or through monthly income is generally better for homeowners, because they spread borrowing over a longer period and the interest charges accumulate more slowly.
 
“Borrowers who withdraw all of their available home equity up front will have fewer resources to draw upon to pay everyday expenses later in life,” the Consumer Financial Protection Bureau warns.
 
Advice for Your Parents and You
 
If your parents or you are considering a reverse mortgage, I think it’s critical to think about how the loan might affect the homeowner’s children and grandchildren.
 
Start by asking whether the home is really suitable for its occupants. If spare bedrooms are going to waste, there’s a big yard to maintain or property taxes and homeowner's insurance are heavy, a better option might be to sell the place and use some of the proceeds to buy a cheaper home. The rest of the money can then be put aside for living expenses, a rainy-day fund or to be passed onto the children or grandchildren.
 
A homeowner with reliable income might consider taking out a traditional mortgage or a home equity loan rather than a reverse mortgage. The loan might be larger and fees and interest charges would likely be lower. Of course, going this route would mean making monthly payments.
 
The children — and grandchildren, if they’re grown — could also weigh another alternative to help the homeowner. In the long run, it might make better financial sense for them to provide cash rather than let a reverse mortgage deplete the equity in the home.
 
If your parents decide to apply for a reverse mortgage, it’s a good idea for you to tag along with them to the required counseling session with a federally approved adviser. Then you can assure that all the key issues are explored, like the benefits of a monthly income stream or line of credit over a lump-sum payout.
 
Once your parents have a reverse mortgage, the younger generations would be wise to keep abreast of what’s going on with it to ensure taxes and other obligations are met and that the home won’t go into default.
 
The Consumer Financial Protection Bureau is working on new rules to provide consumers with better disclosure and to better supervise lenders. In the meantime, I encourage you to read the consumer protection guidelines in the appendix of the agency’s reverse mortgage report. They could save your family a lot of grief.