Correction Appended: July 9, 2010
In theory, reverse mortgages should be a great financial innovation. They allow seniors 62 and older the ability to effectively sell their house but continue to live in it mortgage-free. The ultimate buyer is the bank, and it gives the homeowner the value of their house minus the cost of the loan in exchange for the right to sell the property shortly after the person or persons die or move out. A reverse mortgage, unlike a regular one, is also supposed to ensure that the homeowner never owes more on the house than it is worth.
But in practice, banks and brokers often abuse reverse mortgages. Fees on reverse mortgages can run much higher than those for traditional mortgages. Moreover, brokers sometimes push seniors into taking the proceeds of their reverse mortgage as a onetime, upfront payout, increasing their borrowing costs and, as a result, profits for the bank.
What's more, having that large sum on hand all at once makes the seniors targets for other abuses. For instance, many are then sold variable annuities to turn the lump sum back into a monthly payout, layering on more fees for a bank or insurance broker. Few know they could have just had the loan structured as a monthly payout in the first place. "Reverse mortgages are very hard to understand," says lawyer Klein. "The problem isn't the product themselves, but the fact that they are confusing makes it easy for consumers to be taken."
The original version of this story relied on a study of reverse mortgage fees that was three years old. Since then, new federal guidelines have brought down the expense of reverse mortgages.