Reverse mortgages: The next disaster?

This post comes from Marilyn Lewis of MSN Money.

Older homeowners are increasingly jeopardizing their futures by using reverse mortgages in ways for which the loans were not intended, says the Consumer Financial Protection Bureau.

"There is a growing tendency for seniors to obtain the money at a younger age and in a lump sum instead of annual installments designed to spread the dollars through their retirement -- problems that could accelerate as the baby boom generation goes gray," sums up the Los Angeles Times.

The Times adds:

"There may be circumstances where the reverse mortgage is appropriate . . . but the seniors I've talked to really are a bit confused about what it is all about," said Hubert H. "Skip" Humphrey III, head of the bureau's Office of Older Americans. "They're told there's money out there that they can get, but there isn't always a description of the cost associated with the product. And the interest rates and other parts of this product are often confusing."

The attractions

Reverse mortgages weren't used much until, in the early 2000s, the loans suddenly became popular. Sales peaked in 2009. Now, purchases have leveled out at roughly the volume sold in 2005-2006.

The loans let homeowners who are at least 62 borrow some of the equity built up in their homes. It's easier to qualify than for a home equity line of credit.

You make no monthly payments and don't pay off the loan until you sell the home or die, when everyone living there must leave. If your home sells for less than you owe, you are forgiven the difference. If it sells for more, you or your heirs get the difference.

If you live there long enough after borrowing, it's possible to use up the equity you borrowed and stay by renting -- occasionally for free, making it an extremely good deal. (Post continues below video.)

The risks

But that's a gamble. Most borrowers stay only five or six years after getting the reverse mortgage, the CFPB says in its report to Congress (.pdf file).

Meanwhile, you face steep fees. "Borrowers must pay a loan origination fee, closing costs, and compounding interests on the loan principal, which can be significant," says Consumers Union, the nonprofit organization that publishes Consumer Reports.

The Consumer Financial Protection Bureau gives the example of a $166,434 reverse mortgage: After 10 years, the fees and interest could amount to $56,300.

Also, reverse mortgages are complicated and confusing, making borrowers vulnerable to scammers. Many seniors don't even realize that a reverse mortgage is a loan.

Unlike a traditional mortgage, which you pay down monthly, a reverse mortgage balance grows bigger each month. "The rising balance, falling equity nature of reverse mortgages is particularly difficult for consumers to grasp," the bureau says.

The bureau's report draws a picture of financially troubled Americans using reverse mortgages to keep their heads above water in the short term, failing to understand the potentially serious costs and consequences for their old age.

Homeowners are taking reverse mortgages at a younger age -- many in their 60s and some even before retirement. These younger seniors could live many more years and are depleting their equity cushion, leaving nothing for big expenses, like home repairs and medical bills, for which reverse mortgages were intended.

"It was anticipated that most, though not all, borrowers would use their loans to age in place, living in their current homes for the rest of their lives or at least until they needed skilled care," the bureau's report says.

The lump-sum dilemma

Today, most borrowers take their money in a lump sum, rather than as a line of credit or monthly payments.

This creates problems. Stockbrokers, insurance salespeople, financial advisers and others who earn commissions and fees investing and managing money have powerful incentives for encouraging lump sums. But if you don't need all that money immediately, you'll not only incur unnecessary costs, you'll also be stuck with low returns on savings and investments. You could easily end up paying more in interest and fees than you're earning, making the lump-sum option a losing proposition.

"You could face foreclosure if you run out of money to pay property taxes, insurance, or other expenses in the future," the bureau cautions.

Once you take out a reverse mortgage, you must stay put or sell. You can lose the home or the loan (and have to repay it) if you:

• Neglect the maintenance and upkeep.
• Fail to pay the insurance or property taxes.
• Live elsewhere for 12 consecutive months.
• Fail to meet other obligations in your contract.

Solutions for confusion

There are alternatives to reverse mortgages: selling the home, downsizing to a cheaper location, qualifying for a traditional mortgage, or moving in with children or into senior housing.

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HUD housing counselors (a fee may be required) can help, although the quality of the advice varies, the bureau says. (Counseling is mandatory before getting a reverse mortgage.) Find a counseling agency here or call (800) 569-4287.

Take the counseling seriously, the bureau advises. Learn all your options. You may be eligible for benefits like Supplemental Security Income, state and local energy assistance programs, or loans that could help you stay in your home. Use the National Council on Aging's BenefitsCheckUp quiz to find programs, eligibility and contact information in your area.

More from MSN Money:

• Calculator: How much house can you afford?
• A deal that could save your parents
• Are you saving enough for retirement?
• Could Grandma lose her house?
• Today's best home-equity rates
• Poverty rising among US retirees