Dealing with the Reverse-Mortgage Loan-Servicing Companies
The one area of complaints in the Consumer Financial Protection Bureau report that readers should remain wary about relates to loan servicing. Consumers have complained that servicers can make it difficult to coordinate repayment, may act as if property taxes and other homeowner obligations have not been met and improperly try to foreclose on a loan, do not maintain accurate records (or even lose important documents), and are unresponsive to communications. As well, when the loan balance becomes due, some have complained of appraisers inflating home values to force a higher payoff amount when the nonrecourse aspects of the loan are in effect. Since the loan balance continues to grow with interest until repayment is made, delays in this area also have the effect of increasing the subsequent amount due.
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One example I have personally witnessed is of a reader who obtained a reverse mortgage and then experienced hail damage to the roof of the home. The homeowner’s insurance provided a check to repair the roof but made it out to both the homeowner and the reverse-mortgage servicing company. The reverse-mortgage servicer was very unresponsive and uncooperative about endorsing the check so that it could be cashed and the roof could be repaired.
Fortunately, in this case, the reverse-mortgage lender who had initiated the loan stepped in and worked with the servicer to make sure that the right actions were taken. The lender was not obligated to help with this; it may, however, indicate that working with someone locally (rather than remotely, through a call center) can be important for getting help with future servicing issues. It may be worth paying a bit more in up-front costs to work with someone who can serve as a trustworthy advocate in this area. Choosing a servicer for a reverse mortgage is no guarantee, though, because just like with traditional mortgages, these loans are traded, and you may end up with a quite different servicer than you expect.
Temptations to Use Irresponsibly
Another risk for reverse mortgages relates to the fact that spending down home equity does mean that less of it will be available later in retirement. Any outstanding loan balance on a reverse mortgage grows with interest over time. Borrowers must understand this point.
Creating liquidity for home equity with a reverse mortgage can allow for more strategic retirement-income plans that better protect against retirement sequence risk for portfolio distributions. But there is always a temptation to overspend when the money is available. For those who might look at a reverse mortgage as a means to overspend, this could jeopardize the ability to meet spending obligations later in retirement. Such individuals may be better off keeping their home equity illiquid and thereby avoid misusing the potential benefits of liquidity.
For those who incorporate reverse mortgages as part of a responsible overall plan and don’t use the home equity on unnecessary luxuries, this risk is not relevant. But it remains a risk for those without adequate self-control.
Qualifying for Means-Tested Benefits
Proceeds from a reverse mortgage can be described as “tax free” in the sense that these cash flows do not count as part of the adjusted gross income for determining income taxes. However, spending from a reverse mortgage, or holding some reverse-mortgage proceeds in a bank account, could reduce eligibility for means-tested benefits like Supplemental Security Income or Medicaid. For those thinking about reverse mortgages as a “last-resort” option, it is important to consider the potential impact of the reverse mortgage on other government benefits.
Destruction of the Home through Natural Disasters
A common question I receive relates to what happens to the reverse mortgage if a home is destroyed through earthquake, flood, fire, and the like. Generally, the homeowner has sufficient insurance coverage to rebuild the home on the same property, and the disaster event will not trigger the loan balance to become due. However, the loan balance could become due if one has insufficient insurance coverage to rebuild or decides to move to a new location because it is impossible to rebuild on the same property.
The risk here is that the loan balance could become due sooner than the borrower had expected. For those with sufficient remaining assets, this could be a nuisance but not necessarily a severe disruption for the success of the retirement plan.
But this risk can be particularly problematic for those using a reverse mortgage as a last-resort option once other assets deplete. An extreme example of this risk took place in Oregon in 2012, when a woman in her eighties had her home taken through eminent domain to allow a highway expansion through her area. The woman had already spent the proceeds from the reverse mortgage and had enough income to continue maintaining the obligations to stay in her home. But while the eminent-domain action compensated her for the value of the home, the money had to be used to repay the loan balance on the reverse mortgage, because she could no longer live on the property and was no longer eligible. In this case, the unexpected need to repay the reverse-mortgage loan because of the eminent-domain action essentially left her homeless. Any natural disaster that requires a move from the original property could essentially have the same impact.
For those without other options, it is important to also consider what the alternatives would have been without the reverse mortgage. While the situation is bad when one can unexpectedly no longer live in the home, this type of outcome might simply have occurred even earlier in the absence of the reverse mortgage. With this risk, it is not clear that a reverse mortgage was a bad idea, unless it was being used simply to fund frivolous expenses.
This is an excerpt from Wade Pfau’s book, Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement (The Retirement Researcher’s Guide Series), available now on Amazon.