Thousands of senior homeowners will turn into more sophisticated mortgage shoppers under new proposals unveiled recently by the Federal Reserve Board.
The proposals, expected to take effect this year, will force lenders offering reverse mortgages anywhere in the United States to make detailed new cost disclosures that allow consumers to readily compare the pros and cons of competing loans.
Reverse mortgages function much like the name suggests: Rather than the homeowner sending money to the lender, the lender instead sends checks to the consumer on either a regular schedule or line of credit basis. Although some reverse mortgages require full repayment of the debt at the end of a finite term like five or 10 years, the most popular plans ask for no repayment until the borrower sells the house, moves out or dies.
A 70-year-old widower, for example, might opt for a reverse mortgage that pays him $500 a month. The accumulated debt on his home builds up over the remainder of his life--say 12 years. Only after he passes away and his home is sold does the lender collect the principal, interest and any other compensation built into the loan.
Reverse mortgages are available from a growing number of private and public sources. The Federal Housing Administration's program produced about 5,000 new loans in the past year, and major financial institutions like TransAmerica Corp. have become active players. Reverse mortgages are expected to increase sharply in use during the coming two decades as home equity-rich baby boomers begin to tap their real estate to generate current income.
The new Fed disclosure proposals, designed to implement legislation enacted in September, "will mean that (lenders) won't be able to hide anything," said Ken Scholen, director of the National Center for Home Equity Conversion. That's particularly important, Scholen added, because reverse mortgages are inherently complex financial instruments and "very difficult for the average borrower to understand."
For example, some reverse mortgages carry adjustable interest rates and cut the lender into sharing the future appreciation in value of the property. Others involve purchase of an insurance annuity contract as part of the deal. Competing programs can carry widely varying closing costs, origination fees, mortgage insurance and other charges. On top of that, the basic annual costs within programs often vary according to how long the borrower remains alive and in the house.
A loan with a basic 10% rate, for instance, could cost an unlucky borrower 20%, 30% or more under certain circumstances. A competing loan with the same rate but different fees or terms might cost considerably less, but under current federal truth-in-lending rules the borrower would have no way to compare.
To remedy the confusion--and potential for abuse--the Fed's proposal calls for nationwide uniform disclosures of key loan features. The standard form to be delivered to all loan applicants would force the lender to compute the credit costs under multiple scenarios, including shorter-than-expected payoffs (two-year term), the borrower's actuarial life expectancy and a loan term 1.4 times the borrower's life expectancy. The calculations would produce credit estimates encompassing all the expenses--the base interest rate, plus shared appreciation, mortgage insurance, annuity fees, etc.--expressed as annualized percentage rate charges.
Here's a relatively simple example of how it would work. Say you're a 75-year-old single woman with a house appraised at $100,000. You're interested in learning what the true costs to you might be on a 9% fixed-rate reverse mortgage paying you $301.80 a month for life, plus an initial drawdown of $1,000 and a line of credit worth $4,000. The loan carries $2,500 in closing costs, a $2,000 mortgage insurance premium, a monthly mortgage insurance charge of .05% and a $25 monthly servicing charge. The mortgage would not allow the lender to share future appreciation on the property. The lender would also be prohibited from collecting any more than 93% of the net sale proceeds of the house, no matter how long you lived.
On its face, the loan looks fairly easy to figure: A 9% rate on whatever you've borrowed by the time you die.
Wrong. Using the Fed's new analytical matrix, the applicant would discover that her 9% plain-vanilla mortgage could cost her 39.8% a year if she died unexpectedly after two years--thanks to the heavy upfront fees on top of the initial loan payout.
If she lived for 12 years--her expected life according to actuarial tables--the annualized cost could dip to as low as 10.8%.
However, if the borrower wanted the lowest possible annualized rate on the mortgage, the Fed's form would reveal how to do it: Live long. If she lived another 17 years to the age of 92--1.4 times her expected age at death--her annualized rate on the loan could drop to as low as 4.6%.
Who says you can't beat the system?
Distributed by the Washington Post Writers Group .