10 examples of bad reverse mortgage advice

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Misconceptions don’t only lie in the minds of older homeowners. Occasionally reverse mortgage originators unwittingly reinforce them. While simple anecdotes and analogies are convenient simplifying the explanation of a complex loan, they can sow the seeds of misunderstanding.

Here are just a few of the simple yet misleading explanations that have been touted for reverse mortgages:

  1. A reverse mortgage gives you a portion of your home’s equityFACT: If that truly were the case, the available proceeds would be considerably less. A portion of the borrower’s home value is provided to qualified homeowners.
  2. A reverse mortgage generates monthly ‘income’. FACT: A reverse mortgage can NEVER generate income. It can generate loan proceeds. Income increases one’s net worth. A reverse mortgage does no such thing. 
  3. It’s tax-free income. FACT: The reason reverse mortgage funds are generally not taxable is that they are not income by any definition. See #2.  
  4. You can live in your home for the rest of your life. FACT: Only if the borrower meets the ongoing requirements of the loan or does not move into an outside long-term care facility.
  5. You can’t outlive the loanFACT: Yes you can if the homeowner is in default OR they exhaust the available funds of the reverse mortgage. Both can be easily seen by the borrower as ‘outliving the loan’.
  6. Your Lifetime Expectancy Set Aside will pay your property charges until you dieFACT: LESA set-asides can run out of money if the borrower lives longer than the money in that account would pay property charges.
  7. The line of credit grows continuously with no limitationsFACT: The principal limit (or line of credit) typically increases each month but in some cases, it can actually decrease!
  8. You only need to have enough equity to qualifyFACT: Applicants must pass a financial assessment and have to meet other qualifications at the time of application.
  9. A HECM is a way to leverage your wealth. FACT: Leverage typically means one uses different financial assets to increase the value of another investment. Precise language is important. A more accurate explanation would be that a reverse mortgage is a way to tap into a portion of your housing wealth or the home’s value.
  10. A fixed-rate reverse mortgage is the best choice. FACT:  Like any mortgage, the type of loan and how it’s structured should be based on the unique needs of the homeowner. Do they need the supplemental cash flow now or at some time in the future? If so, a fixed-rate loan would be the worst choice as they would have no access to a line of credit (principal limit). If the homeowner is starting with a low balance a fixed rate would unnecessarily accelerate their loan balance. Are they using nearly all the available proceeds after paying off the home and the initial draw? In such a situation a fixed-rate loan may be the best choice as it’s more likely that interest rates will go up in the future rather than down.

Regardless of our experience, it is always wise to reexamine the words we use when communicating with older homeowners, family members, and financial professionals. Are they accurate, confusing, or misleading? Will they create potential headaches in the future for the homeowner or your lender? The answer truly depends upon the accuracy and clarity of your communications.

What misleading explanations of reverse mortgages are you seeing? Leave your comments below.

8 comments

Amy Smith May 11, 2021 at 4:35 am

Hi Shannon, can you explain in what scenarios the line of credit could decrease?

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Shannon Hicks May 11, 2021 at 10:54 am

The line of credit can go negative when a monthly servicing fee exceeds the available line of credit. For example if six years ago a homeowner began with a $2,000 line of credit and the monthly servicing was $25 the line of credit could be reduced by $1,800 over that time period. In another few years that available LOC could easily be negative. While not common today, this situation could return if servicing fees are charged to those with a negligible starting available line of credit.

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Christian Mills May 11, 2021 at 9:29 am

Thanks, Shannon. These are great info bites. I always benefit from hearing how other experts position our products and serivces.

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Karen Pryor May 11, 2021 at 1:12 pm

Great info Shannon – thank you!

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James E. Veale, CPA, MBT May 13, 2021 at 4:13 pm

Here is one of of the worst I hear. It goes something like this: “After looking at a number of scenarios this is the best refinance option for you.” When asking the originator what that means, the answer and logic behind it are fascinating.

What I have yet to hear is that a team of advisors has looked over the refinance opportunity and agreed that the client should move forward with it. The one thing that is rarely brought up is the income tax ramifications of the refinance and the need to make sure that the borrower will be available to utilize any available deductible interest in the tax year that the refinance closes. When this is brought up, the excuses begin to fly as to why this is not done. The best and most meaningful I have heard is that the experience of the origination (in this case a long-time member of our community) is that CPAs and financial advisors generally are negative towards reverse mortgages and due to their influence can cause the existing borrower to decline moving forward with the refinance. So is the refinance in the best interests of the borrower or the originator?

Then others claim they got all of the information that is needed to make that determination. It is at that time I have laugh and tell them that a process of collecting financial data for a mortgage that only involves getting sufficient information to pass a very skeletal financial assessment is hardly the information that is needed to do any kind of effective or efficient income tax planning. Normally those arguments go silent at this point. I further point up that is not analysis of tax laden assets and what might be considered ordinary income, capital gains, or capital gains on specific types of property that are subject to the special 28% rate.

Then there are the novices who ask what tax issues were all that important with a refinance. This shows how deficient our training as originators really is. The answer is that a refinance generally results in an IRS Form 1098 being sent to the borrower showing that the accrued interest on the previously existing reverse mortgage has been paid in full. Generally, by the time that the Form 1098 is received by the borrower it is already the next tax year and any planning opportunity is gone forever. For those who do not know about home mortgage interest, any interest that is paid in one tax year cannot be carried forward or backward so that the borrower can get any benefit to the extent that they did not receive any tax benefit in the year that the interest is paid.

Then I ask originators if they took into consideration the fact that refinancing with the same lender is not considered a pay off of the interest since no cash is involved between unrelated parties in the transaction. The IRS considers that nothing more than a mere bookkeeping entry even if the lender issues a Form 1098. Most originators respond that they are not responsible for knowing that which may be true legally but is it true morally and ethically?.

With the help of someone who knows income tax law AND the facts, circumstances and tax ramifications of the income and assets that the borrower (and his or her heirs) holds and owns, no originator is able to provide any relevant tax advice to the borrower other than stating that they should seek the help of those who can advise them on such matters.

In some cases the value of the income tax deduction could far exceed the amount of additional funds that the borrower might receive and more importantly, it may provide additional funds beyond that additional loan proceeds from the reverse mortgage for use by the borrower. A deduction of a sufficient amount could mitigate the cost of converting a taxable IRA or 401(k) into a Roth IRA.

Food for thought when dealing with refinancing.

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The Cynic May 14, 2021 at 1:25 pm

There are many things wrong with what we present. Take, for example, Shannon’s second point: “A reverse mortgage generates monthly ‘income.’”

Do any proprietary reverse mortgages have an option for monthly proceeds? What about a fixed rate HECM? Simple statements convey al lot of meaning and in this case, a LOT of FALSE information. One could easily interpret this statement as one intended to mislead a senior. Why not just say: “Adjustable rate HECM’s have a monthly cash payout option?” That has four more words but it is materially correct.

This goes back to the old axiom that gives us the right to say: “A Russian wolf hound is a dog but thankfully, not all dogs are Russian wolf hounds.” In that vein, adjustable rate HECMs are reverse mortgages BUT not all reverse mortgages are adjustable rate HECMs.

We can get it right so what is the excuse for making this statement when no reverse mortgage generates income. Are we afraid of stating the facts? As Cary Grant’s so artful character claims in the film North by Northwest In the world of advertising there is no such thing as a lie, there is only expedient exaggeration.” Is that what our industry is promoting with statements like that made in the second point?

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The Positive Realist May 14, 2021 at 1:35 pm

How about the old faithful anecdote that nonrecourse means that ‘you can never owe more than the value of the home.”

Yet at termination a borrower can never keep the collateral (the home) unless the unpaid balance on the loan is paid in full, no matter what the value of the home. What is true is that a lender can never obtain a deficiency judgement against the borrower at termination with a HECM.

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The Critic May 14, 2021 at 1:40 pm

While I concur with Shannon on the following point, I also think the same meaning can be conveyed with a well placed change: “A HECM is a way to leverage your wealth.” Here is what can be said: “A HECM can be used as an indirect means of leveraging your portfolio or other assets which are not directly related to your principal residence.”

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