Reverse mortgages can be complicated financial products that many borrowers find hard to understand. To help clear things up, the Federal Reserve is proposing a new set of disclosures to provide a better understanding of the costs and risks associated with them.

Key among them is eliminating a longstanding method of illustrating the potential costs of a reverse mortgage and replacing it with something more straightforward. The Total Annual Loan Cost (TALC) method has been in use for two decades, though few homeowners seem to understand how it works.

Other new rules would prohibit loan originators from requiring that a borrower purchase another financial product, such as an annuity, as a condition of being approved for a reverse mortgage. They would also require that borrowers receive independent financial counseling before a reverse mortgage is finalized or being charged any fees.

There would also be new restrictions on advertising for reverse mortgages designed to ensure that they present accurate information.

A type of home equity loan

Reverse mortgages, officially known as home equity conversion loans, are a type of home equity loan available to homeowners age 62 and above. In essence, they allow homeowners to borrow against the equity in their home and not have to repay it for as long as they live there.

The loans are designed to be repaid when the home is eventually sold after the owner(s) no longer live there. A key feature is that they are non-recourse loans - the borrower's obligation to repay is limited to whatever the property is worth at the time it is eventually vacated.

New disclosures make costs easier to understand

One of the reasons for TALC is that it's difficult to predict what a reverse mortgage will end up costing the borrower in the long run. The term of the loan is basically open-ended, with interest charges and sometimes payments to the borrower continuing for as long as the property is occupied, so it's hard to know what the final loan balance will be when the property is sold.

In addition, the value of the property may fluctuate, so that the eventual sale of the property may not cover the final loan balance - meaning the borrower, or their estate, essentially received money that doesn't have to be repaid. (On the other hand, the borrower or their estate still gets the difference if the sale price exceeds the loan balance).

TALC sought to illustrate how these costs would vary depending on how long the borrower stayed in the home variances in the value of the property. However, in workshops with actual homeowners, the Federal Reserve found that few of them could understand what TALC was supposed to be showing them.

The new disclosure rules replace TALC with a more straightforward system that simply shows the actual costs each month.

Clearing up other misconceptions

The workshops also found a number of misconceptions among senior homeowners about reverse mortgages, including the false impression that the borrowers is giving the bank possession of the home; that if the loan balance exceeds the value of the home, the borrower must pay the difference; and that a borrower's monthly payments will stop if their equity ever drops to zero. The new disclosures are designed to address these and other misconceptions.

The proposed new rules and disclosures will be available for public comment for 90 days after their publication in the Federal Register before being finalized.

Published on September 1, 2010