Reverse mortgages, which hold great promise as a way for the frail elderly to pay for long-term care costs while living at home, are failing to do the job. Few homeowners ever take out these loans, and those who do, paradoxically, may be putting their financial security in old age at greater risk.

According to a new report  to Congress by the federal Consumer Financial Protection Bureau, only about 70,000 homeowners –or 2 to 3 percent of those eligible—tap their home equity with RMs each year.  However, borrowers are younger than ever and more likely to take proceeds as a lump sum, thus potentially reducing assets they’ll have available to pay for long-term care costs as they age.

Homeowners may take out an RM starting at age 62. These loans give them access to their home equity right away, either through a lump sum, monthly payments, or a line of credit. In contrast to a traditional mortgage or home equity loan, borrowers make no loan payments while they live in the house. However, their equity decreases over time as their interest costs build up. When the borrower dies or moves (for instance, to a nursing home), the loan plus interest must be repaid immediately.

Nearly all RMs are insured by the Federal Housing Administration through its Home Equity Conversion Mortgage (HECM) program.  With a standard HECM loan, borrowers pay relatively high fees but can receive as much as 77 percent of their home’s appraised value (depending on the borrower’s age). They can also choose an alternative, called a HECM Saver loan, where they pay much lower fees but can borrow less and may pay a higher effective interest rate.

As a result of the housing crash, as well as recent market and regulatory changes, RMs look very different today than five years ago.  Before 2007, nearly all borrowers chose adjustable rate loans. Today, 70 percent of HECM loans are fixed rate, where proceeds are disbursed only through a single lump sum.

In 2000, about 20 percent of borrowers were 62-69. But 2011, 47 percent were in their 60’s. By contrast, in 2000 half of borrowers were age 70-79 while in 2011 only one-third were 70-something.  Many of these relatively young borrowers are using that upfront cash for everyday expenses (and frequently to pay off existing debts).  

The problem is RMs eat into home equity over time. If someone borrows in their 60s, and spends the money right away, that will leave them with fewer financial resources in old age when they may need those funds the most. In effect, if it is too easy to borrow against your home when you are relatively young, you will have less equity when you really need it for long-term services. Worse, nearly 10 percent of reverse mortgage borrowers were at risk of foreclosure due to non-payment of taxes and insurance as of February, 2012, according to the CFPB report. As a result, even with the RM funds, they are at risk of losing their homes.

For most households, home equity remains their largest single financial asset. And it has the potential to serve as a critical source of funding for the cost of long-term care services and supports. As a concept, reverse mortgages are a terrific way to turn that equity into needed cash. But in practice, they are failing to do the job and, for many borrowers, may be making things worse.