WASHINGTON — Three years ago, with his former partner suffering from cancer, Jim Dorsey decided to borrow against the equity on his Vashon Island, Wash., home with a reverse mortgage. The couple didn't have children and didn't plan to move, so a loan that didn't have to be repaid until he died seemed like a good deal.
Dorsey, 69, isn't so sure now.
The retired high-school teacher figures the loan — which netted him a $75,000 lump sum after paying off his mortgage — will reduce his home equity by $100,000, compared with what it otherwise might have been if he lives another decade.
Then again, Dorsey can stay in the house for as long as he pays his property taxes and homeowners insurance. Plus, he won't be liable for the shortfall if his final loan balance exceeds his home's value, either because of falling real-estate prices or because he lives longer than expected.
That's because almost all reverse mortgages since 1989 have been insured by the Federal Housing Administration. The agency collects mortgage-insurance premiums from borrowers, much of which are used to make lenders whole if borrowers default or if home prices drop.
“The feds are assuming the risk,” he said. “The bank is in the catbird seat.”
That risk has put the FHA's reverse-mortgage portfolio $5.25 billion in the hole as worrisome numbers of borrowers fail to keep up with taxes and insurance or convey their homes to the FHA rather than go through the expense of marketing and selling their properties.
In response, Congress recently passed legislation sponsored by U.S. Rep. Denny Heck, D-Wash., allowing the FHA to fast-track changes to stem the deficit. President Obama signed the bill. The agency plans to use the new authority to tighten lending terms that could reduce loan amounts or even disqualify some borrowers.
Among the proposed changes are requiring a review of applicants' finances before granting a loan and mandating an escrow account to set aside money for taxes and insurance.
The new rules are scheduled to take effect Oct. 1.
The legislation's passage comes on the heels of an FHA administrative action in April to steer borrowers to lower-fee, lower-payout loans to reduce stress on its insurance fund.
Some consumer advocates fear the pending changes could lock senior citizens out of reverse mortgages or drastically lower their borrowing limits. That's a worry because retirement experts expect more pension- and savings-poor Americans to tap their home equity after paychecks end.
Heck said his legislation was a “twofer” win for senior citizens and taxpayers. It gives the FHA quick authority to shore up its reverse-mortgage program of Home Equity Conversion Mortgages (HECM), Heck said, and protects against defaults and minimizes the tab for the U.S. Treasury.
Erin Reardon, a reverse-mortgage counselor with Solid Ground, a nonprofit anti-poverty group in Seattle, warned that the FHA's new guidelines could sow more confusion with a product that's already complicated.
Reardon said one of the attractions of reverse mortgages is that they do not require credit histories or sufficient cash flow. She's waiting to find out if the FHA's new financial-assessment rules might knock out potential borrowers.
Reardon also worried that mandatory reserves for taxes and insurance might leave some senior citizens with little or nothing from their home equity. The FHA has not issued formal guidelines, but agency officials have indicated the escrow set-asides could equal two years' worth of taxes and insurance or even cover the full duration of the loan, which can last 30 years or longer.
As of February 2012, a record 54,000 borrowers, or 9.4 percent of reverse-mortgage holders, were at risk of foreclosure because they failed to keep up with property taxes and homeowners insurance.
The FHA also intends to limit the amount borrowers can draw at the beginning of the loan, possibly tied to the size of the mortgage they need to pay off and other types of debt.
The number of Americans taking out reverse mortgages fell for a third straight year to 54,591 in fiscal 2012. But that number is expected to spike in coming years as more baby boomers finance retirement.
Dorsey, who separated from his partner, said reverse mortgages come with trade-offs: cash now or equity later. He said fees ate up much of his original draw. But he can stay put as long as he keeps his home in good repair.
“Do you need the cash? If so, then reverse mortgages may be a sound choice,” he said. “Do you value future equity? If so, then reverse mortgages may not be a good choice.”
How do reverse mortgages work?
The loans can help cash-poor senior citizens tap the equity in homes without moving out. But borrowers often lack a full grasp of how they work. They are the opposite of traditional, or “forward,” mortgages: Your loan balance grows — and home equity shrinks — over time.
» Who qualifies?
Homeowners who are at least 62. You must be mortgage-free or have a small balance that will be paid off with proceeds from the reverse mortgage.
» Borrowing limits
You can borrow against homes of any value, but loan proceeds are capped at homes appraised at $625,500. The loan size depends on the age of the borrower, the interest rate and required fees. But roughly, on a $200,000 home, a 65-year-old could get about $120,000 after closing costs and other fees. At 85, the same borrower could get about $155,000.
» Interest and fees
Reverse mortgages have similar costs as regular mortgages. For instance, they carry origination fees of up to $6,000 on homes appraised at $400,000 or higher. And some borrowers must pay an upfront 2 percent mortgage-insurance premium, plus 1.25 percent annually. There are also closing costs, such as title searches, home appraisal, recording fees and mortgage taxes.
Borrowers can opt for lump-sum draws, regular payments or a line of credit. They must pay property taxes and homeowners insurance to avoid foreclosure. The loans come due when owners move out, sell or die. The final balance can exceed the home's sale price. The borrowers or their heirs are not liable for the shortfall.
Sources: Federal Housing Administration, Consumer Financial Protection Bureau, Center for Retirement Research at Boston College