Proposed guidelines for reverse mortgages spell out potential pitfalls for homeowners

If you, your relatives or friends are contemplating applying for a reverse mortgage in 2010, check out the new guidelines proposed this month by the federal regulatory agencies for financial institutions.

Though aimed at banks and credit unions, the guidelines neatly sum up the potential snares and pitfalls for consumers in the fast-growing reverse mortgage field. Reverse mortgages typically are restricted to homeowners 62 and older who have untapped equity available and want to turn it into cash.

Borrowers can receive lump-sum payments, credit lines, periodic disbursements or a combination. The funds drawn down incur interest charges and fees for insurance and servicing, which generally must be paid back only after the occurrence of a so-called "maturity event" -- when the borrower sells, moves, dies, fails to make property tax and insurance payments or allows the house to deteriorate substantially.

When properly understood by seniors and underwritten responsibly by lenders, reverse mortgages can provide money to supplement retirement income, pay for uninsured medical expenses and keep homes in good repair. But all too often, according to the regulators, seniors are poorly counseled in advance and don't comprehend what they are getting into.

They are misled by direct-mail pitches that imply that reverse mortgages are a government benefit, cost relatively little, never need to be repaid, represent income for life and carry no risk. In fact, reverse mortgages often entail high upfront fees and substantial insurance and servicing charges -- well beyond the costs of other financing alternatives that may be available to seniors.

Banks and credit unions need to spell all this out for seniors in advance of taking reverse mortgage applications, the regulators said. This is a complex financial product that requires extra time and personal financial counseling upfront.

A reverse mortgage isn't a government benefit. Though the predominant form of reverse mortgage is the Home Equity Conversion Mortgage insured by the Federal Housing Administration, the loan itself comes from private lenders. Those lenders -- not the borrowers -- are insured by the government against loss.

Some borrowers are not even aware that the transactions they sign up for are debt instruments requiring repayment. Lenders' marketing materials may make that problem worse by glossing over the payback requirements. "In fact," the regulators said, some lenders' marketing material "has prominently stated that the consumer is not incurring a mortgage, even though the fine print states otherwise."

Other lender problems noted by the regulators include:

* Inappropriate cross-selling of additional financial products, sometimes presented as a requirement for the borrower to obtain a reverse mortgage. These include costly annuities, investment programs and home-repair service contracts.

* Failure by banks to explain the potential downsides of reverse mortgage payment alternatives to applicants upfront. For example, some lump-sum payout options may be inappropriate for certain seniors because they adversely affect their ability to qualify for needs-based public benefits, such as Supplemental Security Income. Lenders should tell applicants about these dangers.

* Failure to inform borrowers upfront about their own responsibilities under reverse mortgage contracts. For example, there may be no escrow account attached to a reverse mortgage -- something borrowers might assume is standard, based on their experience with regular home mortgages. Yet without an escrow that collects money to pay for local property taxes and hazard insurance, reverse mortgage borrowers may not remember to pay those bills themselves.

The regulators' message to banks: Explain all the working parts of the loan upfront, and make sure the borrowers fully understand what they've got to do on taxes and insurance.

Distributed by the Washington Post Writers Group.