Reverse mortgages can be a wonderful tool, particularly for an older homeowner worried about how to pay for the care required to stay comfortably at home as long as possible. The basic concept of a reverse mortgage is a little bit foreign, but not that complicated: typically, the lender pays the homeowner a monthly amount that will be recovered when the homeowner dies, sells the home or moves. Of course, interest and related charges will be included. That structure may be straightforward, but modern "reverse mortgage" financial products can be much more complicated.

Take the "Lifetime" reverse mortgage marketed by Homefirst (and later by Transamerica Company after it purchased Homefirst) in California, and sold to Donald and Helen Flores in 1997. Mr. and Mrs. Flores, aged 79 and 75, were looking for additional income as their care costs increased; the Lifetime product gave them a monthly payment of $994 to help out. When Mrs. Flores suffered a stroke less than three years later and could no longer live at home the couple put their house on the market knowing that they would have to pay back more than the $29,820 they had received. They were more than a little surprised to learn that the reverse mortgage company required repayment of $172,139.

How did the payoff become so large? The complicated Lifetime product was actually a reverse mortgage coupled with an annuity and an equity participation agreement. In other words, upon closing the original loan Transamerica had paid $33,412 to an insurance company for a deferred annuity that would begin making the payments after ten years. The closing documents also included an agreement that any increase in the value of the Flores’ home would be split between the couple and Transamerica; that amounted to another $75,000 to be paid to the lender. Costs, interest (at 9.95% compounded monthly) and a "loan maturity fee" of 2% of the value of the home added another $33,907 to the payoff figure.

The Flores’ children sued Transamerica and the other companies involved in the deal. The trial judge ruled that they had been given adequate information at the time of the reverse mortgage, and denied any recovery. The California Court of Appeals agreed that Mr. and Mrs. Flores had failed to show that they had relied on any failure on the part of the company to fully explain the effect of the agreement they had signed. Trigueros v. Transamerica Corporation, September 25, 2006.

Mr. Flores (Mrs. Flores has since died) should still recover some of his money. A 2003 class action settlement provided a small payment to Lifetime reverse mortgage purchasers, and a separate lawsuit against the insurance company that sold the annuity settled for an undisclosed amount.

What lesson can be learned from Mr. and Mrs. Flores' reverse mortgage experience? It may not be enough to carefully review all the documentation; the Flores', in fact, had been given extensive disclosure and that fact was precisely why they had difficulty setting aside the transaction. In fact, they had been offered two other, more traditional reverse mortgage arrangements (presumably with smaller monthly payments) and specifically rejected them in favor of the Lifetime contract. In their later lawsuit, they unsuccessfully argued that the inclusion of an annuity was by itself a basis for setting the transaction aside because, they insisted, annuities are poor investments for seniors and the particular annuity in their reverse mortgage package was structured so that it would be extremely difficult to receive any return on their "investment" in the policy. Unfortunately, they did not understand that at the time they signed the initial reverse mortgage. They would have been well-advised to consult a financial planner, attorney or other professional with a better grasp of the complicated financial instrument before signing.

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