Skeptical eyes on reverse mortgages

For a cash-starved senior citizen, the opportunity to tap into hundreds of thousands of dollars in home equity can be irresistible. That's why reverse mortgages are becoming more popular, and also why consumer groups and law enforcement officials are warning about a new frontier for scams and fraud.

Today 81 percent of seniors own their own homes and account for a total of more than $4 trillion in home equity, according to the Government National Mortgage Association (Ginnie Mae). By 2030, that figure could grow to $37 trillion. Reverse mortgages are a way for homeowners 62 or older to get at all or most of that equity tax-free without selling their homes. Even better, there are no monthly interest or principal payments during the life of the loan, making it seem like free money. It isn't.

There are important caveats, which is why FBI Director Robert Mueller and Minnesota Attorney General Lori Swanson, among others, are warning consumers to be wary.

One caution is that reverse mortgages can be more costly and less attractive than they appear in promotional materials. Benny L. Cass, an attorney in Washington, D.C., provided this example for the Washington Post:

"Your house is worth $500,000, and you have a $100,000 mortgage. You obtain a $300,000 reverse mortgage, which pays off your existing loan and provides you with about $200,000... In 10 years, assuming that your house appreciates 4 percent a year, it will be worth about $740,000. But even if the interest rate is only 6 percent, at the end of 10 years the loan amount will have increased to $537,000. If at the end of those 10 years you want to downsize and buy a smaller home, or if you plan to leave your house to your children, the remaining equity -- about $200,000 in our example -- may not be sufficient for your needs."

Cass didn't include lender fees or closing costs, which typically are high on such loans. Law enforcement officials and consumer groups are also warning seniors to beware of reverse mortgage deals in which they're pressured to invest loan proceeds in deferred annuities.

The number of loans backed by the Federal Housing Administration -- which account for about 90 percent of reverse mortgages issued -- jumped from 6,637 in 2000 to 107,367 last year. That number will continue to multiply. After the implosion of the subprime mortgage market, lenders need new income streams, and more are likely to turn to reverse mortgage products.

For certain borrowers -- especially those who expect to live in their homes for many years and are less concerned with maximizing what they leave for their heirs -- a reverse mortgage might make sense, and many reputable lenders and financial counselors are available to discuss the pros and cons, as well as alternatives like home equity lines of credit.

But with $4 trillion in play and an aging population faced with growing financial needs and inadequate retirement savings, the reverse mortgage business is ripe for abuse. The warnings from Mueller and Swanson are the kind of alerts we needed before the subprime tsunami. Let's hope they help prevent another mortgage mess.