The Risks and Rewards of Reverse Mortgages

That's significant because in many cases, a reverse mortgage isn't the best option. The product comes with upfront fees that make it unattractive for short-term financing, so anyone planning to change residences within a year or two should probably stay away. (And such fees can make products like home equity lines of credit less costly.) And by dipping into their home equity, reverse mortgage borrowers may be less likely to bequeath their property when they die. As a result, the loan might not be such a great idea for homeowners whose properties have been in their family for generations, says Christopher Fanney, the president and CEO of Seniors First Mortgage Company, which specializes in reverse mortgages. "A reverse mortgage is more of a last-resort kind of option," says David Certner, the legislative policy director for AARP. "It's generally for somebody who is older [and] plans on staying in their home for a longer period of time; they have a lot of equity tied up in the home but not much, if anything, in the way of other resources."

To get the most out of counseling, potential borrowers should do their homework; HUD and AARP have plenty of information about reverse mortgages on their websites. And although 90 percent of such counseling sessions are conducted over the phone, it's worthwhile to arrange a face-to-face meeting, says Peter Bell, the president of the National Reverse Mortgage Lenders Association. Don't just go through the motions—come to the session with questions, and don't leave until you've got reverse mortgages down cold. If you are unsatisfied or uncomfortable with your counselor, find another one.

2. Inappropriate investments: Borrowers will need one of the FHA-approved lenders, a list of which can be found on HUD's website, to handle their reverse mortgage. Finding a competent, honest lender is essential, as incidents of abuse have been reported. By allowing property owners to extract equity from their homes, reverse mortgages can give borrowers access to a great deal of cash. But along with the funds come risks, as unscrupulous lenders may pressure borrowers to purchase unsuitable financial products—such as annuities—with the proceeds of the loan. Eight states reported at least one case of such inappropriate selling of insurance products from 2005 through January 2009.

Reverse mortgage proceeds should be managed with extreme prudence because in many cases, the cash represents the bulk of the borrower's net worth. "The thing that people should not be doing with a reverse mortgage is trying to create wealth," says Lewis of Generation Mortgage. "Don't tap your house and go out and buy equity-indexed annuities or invest in your uncle's dry-cleaning store."

To find the right lender, get recommendations from others you know who have obtained reverse mortgages. And since the fees associated with the loan can vary from bank to bank, "I would recommend that a borrower talk to a couple of lenders that they feel comfortable with and compare what kind of deal they might get," says Bell of the NRMLA. In addition, Bell suggests checking with the Better Business Bureau or the state banking authority before settling on a lender. Aside from lenders trying to sell you other products, beware of those that pressure you to withdraw more money than you need, Bell says. (The exception is if you get a fixed-rate reverse mortgage, in which case you will most likely be required to take your proceeds in a lump sum.) Again, if you feel unsettled by your reverse mortgage lender in any way, find someone else.

3. Misleading marketing: In its investigation, the GAO found that certain reverse mortgage marketing materials contained potentially misleading statements. One of these claims was that the product allows borrowers to "never lose [their] home." That's not exactly true: While a reverse mortgage relieves a borrower of monthly mortgage bills, the borrower is still responsible for other costs. "Failure to [pay] the property taxes or insurance can result in foreclosure," says John Snyder, the manager of foreclosure programs for NeighborWorks America.