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Ken Harney - The hidden dangers of reverse mortgages

Katherine Stephens is a 94-year-old widow who now lives in a nursing home in southern New Jersey. According to her nephew, William Finch, she has $38 in her bank account. Monthly Social Security checks pay only a small portion of her bills.

In 1988, Stephens and her husband, Harold, signed up for what they thought was a great concept for seniors: A "reverse mortgage" that would pay them $312 a month virtually in perpetuity -- until they died or moved out of their house in Brigantine, N.J., near Atlantic City. At the time, Katherine was 76 and Harold was 78. Harold later died, leaving Katherine alone in the house. The $312 checks came in like clockwork, until early this year, when she moved to the nursing home.

The interest rate on Stephens' mortgage wasn't cheap -- 11.5 percent. When all the fees associated with the loan were rolled into the financing charges, the annual percentage rate (APR) came to 13.43 percent. But those costs were hardly the worst features of Stephens' reverse mortgage. Buried away in the block print of the loan agreement was something called "additional interest."

The "additional interest" provision gave the lender the right to 100 percent of all gains in the market value of the property from the date of settlement to the date of final payoff. At the time of the loan settlement in 1988, the appraised value of Stephens' house was $83,500, according to the mortgage documents. Two recent appraisals put the current market value of the house at roughly $500,000.

From 1988 through January of this year, Ms. Stephens received a total of $67,586.01 in monthly payments -- first from the original reverse mortgage lender, the now-defunct American Homestead Mortgage Corp., and later from Wilmington Savings Fund Society (WSFS), a Delaware bank that purchased American Homestead's portfolio of reverse mortgages in 1994.

WSFS now is demanding that Ms. Stephens pay it:

the $67,586.01 advanced in monthly payouts, plus

$158,218.19 in compounded interest at the 11.5 percent rate, plus

the 100 percent of the house appreciation since 1988 it is entitled to as "additional interest" under the loan contract.

All this comes to $416,500, but the contract puts a "cap" on total potential payouts to the lender at 100 percent of the current appraised value of the house, i.e. $500,000, less selling expenses. Without the cap, Ms. Stephens could have owed WSFS more than $642,000.

Bottom line: WSFS wants nearly half a million dollars in compensation for total loan advances of $67,586.01, dribbled out at $312 a month over 18 years. Only during 12 of those years did the advances come from the bank's own resources.

WSFS is adamant that it receive full payment despite the fact that the debtor is a frail, virtually penniless 94-year-old widow who simply wants to use some of her appreciation proceeds to pay her $4,000-per-month nursing home bills.

"I think it is absolutely disgusting," said nephew Finch, who is 70 and lives in Clermont, Fla.

Finch, who has power-of-attorney for his aunt, said all discussions with WSFS "went nowhere. They took a totally hardball approach." After I contacted WSFS and asked for an explanation, spokeswoman Joan H. Sullivan said in an e-mail reply to me that the bank's reverse mortgage loans comply "fully with federal and state laws and WSFS understands that at the time of these early reverse mortgage originations -- approximately 15 to 20 years ago -- all of the terms and conditions of those loans were fully disclosed to borrowers." Absent "special circumstances," wrote Sullivan, WSFS has always "sought to collect all amounts due to the lender under the contractual terms of the loan."

Benefits provided? You mean the $67,500 in advances versus the $500,000 now demanded? Risks assumed? How big were they really when the $83,500 house securing the $67,500 in advances soared to $500,000 in market value?

Finch has now listed the house for sale. Virtually all of the proceeds appear to be headed to the coffers of a $2.2 billion bank.

The reverse mortgage industry no longer makes equity-grab loans. Major institutions such as Fannie Mae no longer collect interest based on appreciation sharing on reverse mortgages, even when loan contract language entitles them to do so. But that's of no consolation to Ms. Stephens, is it?

Ken Harney is a real estate columnist with the Washington Post.