by Peter G. Miller
January 28th

How risky are reverse mortgages?

That’s a question being raised that the Motley Fool, the generally well-regarded financial site. Blogger CubanStockPicker writes and says that “reverse mortgages pay you to live inside the home. Based on the equity of course. But as we have discovered, equity can vanish quickly when there are too many sellers and too few buyers.

“To qualify for a reverse mortgage, you need to be older than 62 Y/O. The government backs this program, and you don’t have to pay anything, just have your insurance policy made payable to the note holder for the amount of the mortgage and you descendants get a home all clean and paid off.

“One issue though, why would an insurance company do anything as stupid and pay the full balance on a house giving an insurance policy to someone who can never live long enough to pay the average 200,000 mortgage/ insurance policy.”

Actually, of course, the FHA reverse mortgage will only finance a portion of a home’s value. As to getting that home free and clear, nope, the property is security for the loan. When the borrower sells, moves or passes on the loan is repaid by the heirs (perhaps with another loan secured by the house) or by the sale of the property. And, borrowers certainly pay up front to make the loan happen and they also have other costs for ownership over time. What they do not have is an obligation to make monthly mortgage payments for principal and interest.

The importance of FHA insurance is that it pays off borrowers if a lender fails — and it pays lenders for any balance not paid by the heirs or the sale of the property.

As to the issue of risk, as home values have fallen it seems likely that lender claims against HUD will rise. Why? Because in many communities there’s less equity to cover the loan amount for FHA reverse mortgages originated in 2006 and 2007.

In the discussion of risk, however, notice that it’s HUD which has the risk and not borrowers or lenders. As a borrower, once you get your money the issue of risk is HUD’s problem.

Will HUD take a beating on it’s reverse mortgage program? To date that has not been the case as there have been relatively few claims. However, claim levels could rise as home values drop. In a year or two we’ll have a better idea of just how risky, or not risky, reverse loans have been.