The fast-buck peddlers slinking out of the subprime mortgage morass are getting their sticky fingers into reverse mortgages, a business that caters to the vulnerable elderly market. San Diego is no exception. As housing prices zoomed through 2005, older people built up a lot of equity in their homes. In many cases, it made sense to wring cash flow out of those artificially valued houses. But people who take out reverse mortgages pay inordinately high up-front fees that are very profitable to lenders. There are other pitfalls that greedy salespeople might mention only in passing when closing the deal.
Last month, the Senate Special Committee on Aging held a hearing on reverse mortgage abuse. San Diego attorney Ron Marron went to Washington to give information to the investigators. Marron represents a Chula Vista widow who is suing companies that sold her a reverse mortgage and convinced her to put the proceeds in allegedly inappropriate long-term annuities with high charges and penalties that kept her from having timely access to her funds. “It’s called ‘equity stripping,’ ” says Marron. “The people are supposedly getting the reverse mortgage to get liquidity and cash flow, but the broker talks them into putting the money into high-commission financial products, mostly annuities.” Marron will be filing a suit shortly on behalf of another woman allegedly taken by hyperaggressive reverse mortgage salespeople.
These mortgages aren’t inherently bad. “In principle, [the reverse mortgage] is a very nice product,” says Richard Green, professor of real estate and finance at George Washington University, in the nation’s capital. “It enables old people to live off wealth they have accumulated at very little risk to them.” A recent survey by AARP (formerly the American Association of Retired Persons) indicated that more than 90 percent of people who took out reverse mortgages are satisfied.
In a reverse mortgage, people 62 years of age or older are in essence putting up their homes as collateral and receiving regular cash payments from a lender. It’s the opposite of a conventional mortgage, in which the borrower pays the lender each month. In a reverse mortgage, the lender is paying the borrower regularly, based on the value of the home. When the borrower dies or is forced to move out of the home for 12 months, the house is normally sold to pay off the balance of the mortgage. That’s a disadvantage right there: older people often break their hips and suffer other health woes. “They have to go to a nursing home and may be out of the house for a year,” says Lois Kelly, litigation attorney for Elder Law and Advocacy in San Diego. “The reverse mortgage comes due; you have to pay off the lender.”
Ninety percent of reverse mortgages are issued through the federally insured Home Equity Conversion Mortgage Program of the Federal Housing Administration. These mortgages are burgeoning: they began in the 1960s but still hadn’t gone anywhere three decades later. In 2005, there were 76,000 such mortgages offered. That grew to more than 100,000 last year.
The growth is expected to continue, even with home prices falling across the country and lenders in deep doo-doo. Last month, at the Senate special committee meeting, Senator Claire McCaskill (D-Mo.) said that with the market growing, “We are aware of reports of unscrupulous and predatory activities at some of the companies that are marketing reverse mortgages as well as excessive fees to service the loan. It seems obvious that one of the reasons for the unprecedented growth of this market is due to the fact that there is a lot of money to be made.”
Committee Chairman Herb Kohl (D-Wis.) noted that some salespeople are seducing seniors into swallowing “a double-dose of bad financial advice: take the cash from a reverse mortgage and use it to fund an unsuitable annuity.… [L]ong term annuities are almost always inappropriate for seniors, as they can tie up retirement savings far beyond one’s life expectancy.”
The committee was told of a 92-year-old who put $650,000 in a deferred annuity that didn’t mature until 2063. He died two years later. His family had to pay $100,000 to break the contract and access the money.
On behalf of Ernestine Boach, Marron is suing Orange County’s Financial Freedom and its parent, Pasadena’s Indymac Bank, along with several insurance companies. Financial Freedom talked her into getting a reverse mortgage and then putting the money into deferred annuities, in which payments from the insurance company are delayed too long for a senior citizen, who might die before getting them. All told, the machinations ate up 88 percent of the equity in her home, charges the suit. The defendants got fat on fees, commissions, points, charges, and penalties.
Financial Freedom was working through the government’s Home Equity Conversion Mortgage Program. Under that program, buyers of reverse mortgages must get the advice of independent consultants. It’s a fraud-prevention measure. The counselors told Boach not to buy the annuities, but the defendants told her not to listen, says Marron. There are other suits against Financial Freedom, including a class-action one. The company says all the suits are meritless. Another Financial Freedom horror story was related at the Senate committee hearing. The company was asked to appear before the committee but declined.
Taxpayers can get scammed by reverse mortgages too. With the federal government insuring the mortgages, “There are very real liabilities,” said McCaskill at the hearing. “There are numerous scenarios where the loan balance will exceed the home value. In these instances, the collateral risk falls to [the Department of Housing and Urban Development] and the American taxpayer, because lenders can currently assign these loans to the federal government, thus leaving the taxpayer on the hook for the fees charged on the loan.” She pointed her finger at “the unpredictable and sometimes unrealistic expectation of always increasing home values and low interest rates.”
Amen, says University of California, San Diego economist James Hamilton, reflecting on the subprime mess and current signs that reverse mortgages have problems. “What drove the recklessness in part was an assumption that the home price would continue to appreciate,” says Hamilton. Both borrower and lender could thrive under such a scenario. “But housing prices are guaranteed to come down for the next couple of years. I am worried that we will see [reverse mortgages] unravel, just as we have seen the subprime loans unravel.”
In fall of 2006, the Government National Mortgage Association (Ginnie Mae), a government organization, announced with pride that it was going to securitize reverse mortgages — that is, sell them to investors. Uh-oh. The securitization process in subprime mortgages is bringing the big Wall Street financial houses to their knees, begging for financial support from countries such as Singapore. The American institutions hold portfolios of smelly mortgages and have already written down tens of billions of dollars, and nobody knows how bad the losses will get.
The reverse mortgage market is much, much smaller than the subprime market, but it could hurt some investors. It’s a shame that a bunch of avaricious peddlers have infiltrated reverse mortgages, which can be a very useful product for older people.