By Dr. James M. Dahle, WCI Founder
You need not assume by this post that I have anything against you using a reverse mortgage or that I think they are a bad product and those who sell them should get some cement shoes. If you truly understand how a reverse mortgage works and still want to use one, I don't have a problem with that. But one of the best ways to understand something is to see the problems with it. Then you can decide if those issues are a big deal to you or not.
Today, let's talk about reverse mortgages, the problems with them, and if they could be right for you.
Home Equity Isn't Doing Nothing
When you take out a traditional mortgage, you agree to a loan term and pay your lender every month until the balance is paid off. A reverse mortgage works the opposite way—you’ll take out a loan on the equity in your home, and your lender will pay you every month. A reverse mortgage gets rid of your monthly mortgage payments and allows you access to regular income. But it can come with large fees, and you must be on guard for scams that try to prey on the older people who are eligible for a reverse mortgage.
Perhaps the thing that bothers me the most about reverse mortgages is the same thing that bothers me about those who advocate carrying a mortgage long into retirement and using HELOCs for various purposes during your career. They like to sell this concept that home equity isn't “doing anything. It's just sitting there being useless.” I vehemently disagree.
The home itself provides “dividends.” That dividend is saved rent. Technically, that home provides the same dividend whether the home is paid off or if you have a 100% LTV mortgage on it. What the home equity itself is really doing is reducing your interest cost for that home. All the other expenses are precisely the same. If the home is 100% paid off, there is no interest cost. If you only have a little home equity, there is a substantial interest cost. The rate for that depends on your tax situation, but the return on your investment is your after-tax mortgage interest rate.
Sure, that might not be a very good rate of return in comparison to the expected long-term return on riskier investments, but it certainly isn't zero. It's probably better than the guaranteed return on many low-risk investments. In addition, the paid-off home eliminates a risk in your life- the risk of the home being foreclosed on if, for some reason, you can no longer pay the mortgage. That risk might not be very high, but it isn't zero. Bottom line: Home equity isn't doing nothing.
A Reverse Mortgage Is a Loan
An important thing to understand about a reverse mortgage is it is a loan. With that loan, comes (almost) all of the problems with owing money to somebody else. These include having to pay interest, carrying the psychological burden of debt, and reducing your future options. For example, if you borrow against something now, you can't borrow against it later.
In addition, a reverse mortgage isn't a particularly attractive loan. The interest rate is 1%-2% higher than a typical mortgage, and you can't even deduct the interest. You see, the IRS rules are that you can only deduct interest that you actually pay. Reverse mortgage interest isn't paid until the home is sold. To make matters worse, the interest rate is generally variable. Now that doesn't seem like a big deal in times of low-interest rates, especially for a short-term loan. But a reverse mortgage is not short-term (you hope). It's for the rest of your life. So, when you sign up for a reverse mortgage, you are committing to a high-interest rate, non-deductible, variable-rate loan. That sounds kind of bad when you put it that way, doesn't it?
A Reverse Mortgage Is an Annuity
In some ways, a reverse mortgage is also an annuity. Except it isn't a very good one. It doesn't really care about your gender or health status. It also doesn't guarantee to make payments until you die, even if you choose the tenure option. It only guarantees to make payments while you are living in your house. Want to move? Forget it; no more payments. Need to go to assisted living? There goes your house (unless you or your heirs pay off the loan) and your “annuity” payments. If you're not a big fan of loans and you're not a big fan of annuities, you might not be a big fan of reverse mortgages, which combines the two concepts.
Reverse Mortgages Are Complex
I'm not a big fan of financial products I can't explain to a 7-year-old. Complexity generally favors the issuer and those who sell them. If you're going to bring me a complex product, its advantages better be so overwhelming that it makes up for the fact that I need an actuary to tell if I'm getting a good deal or not. Mixing insurance and investing is usually a bad idea. Mixing home equity, an annuity, and insurance sure makes it hard to tell whether it is a good idea.
You Only Get to Use Part of Your Home Equity
One of the things that bothers me about a reverse mortgage is that you only get to use part of your home equity. Given expected rates of around 5%, that amount is 52%. But the expectation is that, on average, you will lose all or almost all of your home equity in exchange for it. If you really want to use your home equity to its maximum, sell the house, buy a SPIA, use part of the SPIA proceeds to pay the rent on a similar (or even the same) house, and spend the difference on something else. When you move out, you still get the SPIA payments.
In Wade Pfau's excellent Reverse Mortgages book, he shows how the tenure payment for a reverse mortgage is calculated. On a $500,000 house owned by a 62-year-old, he calculates out a monthly payment of $1,498, assuming the upfront mortgage costs are paid from other resources. If you reduce the value of the house by 6% to account for realtor fees, a SPIA for a 62-year-old male on $470,000 is $2,431, or 62% more. Granted, the reverse mortgagee also gets to stay in the house, and that's worth something. However, they are also still responsible for the insurance, taxes, and maintenance that the renter would have covered by a landlord. A reasonable rule of thumb used by real estate investors is that the non-mortgage expenses on a rental property will be about 45% of the rent.
Tricky comparison, right? Most 62-year-olds won't do the math to really know which option comes out ahead, right? But guess who has done the math? The actuaries that work for the lender, and you can bet they're not going to lose money on the deal.
High-Interest Rates Make Reverse Mortgages Much Less Attractive
But wait, there's more. In Pfau's example, expected rates are quite low—so low, in fact, that the 62-year-old was able to borrow 52% of the home equity as a reverse mortgage. At higher effective rates, such as 9.5%, that percentage falls to 15%. It's a lot less attractive to reverse mortgage your $500,000 house when all you get out of it is a loan for $75,000.
I think part of the interest in reverse mortgages over the last few years is that the structure of a reverse mortgage makes it much more attractive in a period of low-interest rates. While annuities become less attractive, reverse mortgages become more attractive with low rates. Conversely, as rates rise, you're probably much better off with a paid-off home than a reverse mortgage. If your expected rate is 9.5%, a 62-year-old can only borrow 15% of the home's value. Yet, the estate might lose the entire value of the home at death. Does that sound like a good deal to you? I think I'd rather give granny some spending cash myself and get 100% of the home's value when she passes.
The Lender Can't Lose
Another aspect of this that I don't like is that it is set up so the lender can't lose. The lender isn't making a bet that you're going to die soon. They don't come out any more ahead by you keeling over the year after you take out the reverse mortgage than 30 years later. Their profit comes from the up-front fees and, if you include the investor in the securitized note in your definition of lender, from the years of interest. Their downside is covered by the federal insurance fund. Guess who pays for that insurance? You did with the mortgage insurance. The reason you either put 20% down or used a physician mortgage when you bought your home in the first place was to avoid mortgage insurance. Yet, now you want to buy it in retirement? Seems odd.
You want to know why lenders are so big on these? Higher fees, higher interest rate, higher closing costs, and losses covered by mortgage insurance—it is all good and no bad for the lender. In fact, there is so much potential bad in this for you that the federal government requires you to go to a counseling session provided by someone besides the lender before you can buy one.
What other consumer products out there make you go to a government-mandated counseling session before you buy? A child? No. A firearm? No. A primary mortgage? No. A Roth IRA? No. Whole life insurance? No. But you do for a reverse mortgage. If that doesn't say “Caveat Emptor,” I don't know what does. At any rate, when the lender can't lose in this deal, someone else has to, and that someone is you. (OK, that's a little harsh. It could be a win-win deal, but it certainly isn't going to be a lose-lose deal, I can tell you that.)
Reverse Mortgages and Paying Taxes
Something that bothered me in Pfau's book was that he consistently used an example of a $500,000 paid-for house and a $1 million investment portfolio. Yet he used a 25% marginal tax rate for that retiree. While I do not dispute it is entirely possible for a retiree with a $1 million portfolio considering a reverse mortgage to have a 25% marginal tax rate, it seems rather high to me.
The Required Minimum Distributions (RMDs) for $1 million at age 72 is $39,000 a year. That portfolio is likely not all tax-deferred. Some of it may be Roth, and some of it is probably taxable. Let's say $500,000 is tax-deferred. That's an RMD of $19,500. Maybe they get another $30,000 in Social Security. But with only $18,000 in taxable income aside from Social Security, they don't pay taxes on Social Security. And they're in a low enough tax bracket that their dividends/capital gains rate is 0%. So, how much federal income tax is this couple really going to pay? Nothing. Zero percent. Certainly not 25%. Now, I'm ignoring state taxes as well, but even together, it's pretty tough to get to 25% when your federal tax is so low.
Pfau also uses that same figure in his analysis of how using a reverse mortgage can make your retirement income spending more efficient, which obviously casts a bit of doubt onto those results as well. But instead of including the tax bill as part of the 4% withdrawal, as I would expect, he adds it to the 4% withdrawal. So, in those examples, the person without the reverse mortgage is withdrawing 5.33%. No surprise that there are a fair amount of scenarios where it doesn't work out well without tapping into additional resources, like home equity.
At any rate, when running your own scenarios when deciding to use a reverse mortgage, make sure you're being realistic about taxes. Taxes in retirement can be ridiculously low—no payroll taxes, much less income than during your peak earnings years, some of that income taxed at capital gains rates, some (Roth) not taxed at all, and a progressive income tax system. The lower your effective tax rate, the less benefit you're going to have swapping interest for taxes. Tax-free sounds awesome, but just like with whole life insurance, tax-free but not interest-free isn't nearly as cool.
The Cap Is Too Low to Move the Needle
The other problem I have with a reverse mortgage for a doctor is the relatively low cap on the amount you can borrow. The maximum home value is $625,000. At best, you can only use 52% of that, or about $325,000. I don't know about you, but I plan to have so much money to retire on that $325,000 isn't going to move the needle for me. Most financially savvy docs I talk to project a financial independence number in the $2 million-$5 million range. At $2 million, $325,000 is only 16% more money. At $5 million, it's only 7%. At a certain point, it's no big deal to just have the house be part of my legacy. When you only have a $1 million nest egg, that $500,000 home is a big part of your assets. When you have a $5 million nest egg, a $500,000 house is not a big part of it. Even if you have a $2 million house, you can only use $325,000 of it using the HECM program.
The House Isn't Staying in the Family
While technically you (and your estate) get to keep the title to the house, the loan becomes due upon your death (or worse, if you move out before death). On average, that loan is going to be the vast majority of the value of the home. If the family wants to keep this house, they're going to have to come up with a lot of money in a hurry to do so.
If using this reverse mortgage really did make your retirement income strategy more efficient, maybe that can be paid out of your estate. But more likely, the family is going to have to give up a significant benefit of your estate to keep the house. I would suspect that most of the time the house isn't going to stay in the family. That's not necessarily a big deal; I don't want my parent's house for instance. But if it matters to you, try to see the end from the beginning.
Malincentive to Move Out
An overlooked aspect of a reverse mortgage is the creation of a malincentive that otherwise wouldn't be there. Sometimes, the right thing to do is to downsize, move to assisted living, or move closer to family. If you have a reverse mortgage, particularly if you have chosen the tenure option, you have limited your options. As soon as you move out, the loan is due. You gave up some future freedom when you took out the reverse mortgage.
The Bottom Line on Reverse Mortgages
If you understand the downsides of a reverse mortgage and still find it attractive for your situation, feel free to go ahead and use it. There are a lot of different ways it can be used, and there is no doubt that you can increase the maximum amount of money you can spend during your lifetime by using a reverse mortgage. However, you need to realize there is precious little free lunch here. Even when using it as a “put” option, there is still a price to be paid for that “insurance.” I doubt I'll ever use one, and I suspect most readers won't either.
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What do you think? Did I miss any downsides of a reverse mortgage? Would you consider one for yourself or a parent? Why or why not? Comment below!
[This updated post was originally published in 2017.]
Thx for what I consider a more balanced post on it. I just don’t find there much new with this topic. It’s still something that is unlikely to be a good deal to people visiting this site. It’s amazing to me how much sellers of what I consider less desirable products always want to say that they are totally different then in the past.
Additionally I dislike when academics seem to cherry pick things like 25% tax rate. It’s hard for me to believe they don’t know better.
There is an innovative financial tool allowing homeowners and residential property owners the ability to access trapped equity without monthly interest payments or the burden of additional debt. It is designed more for high net-worth individuals than other products. Might want to check it out. https://www.seattletimes.com/business/real-estate/tapping-funds-when-youre-equity-rich-but-cash-poor/?amp=1&fbclid=IwAR0Aza20g1coTDZh7z0xZmGUgzYeL6k9mrF3sq-WHrp4Kdm5Fk1ncEHGzwE. This group is one of our subject matter experts and can do an an analysis of the various products.
Now this post is more like it. There had to be catches: only being able to tap into half (at best) of the equity on the home, the inflexibility of the product with sudden life changes, and upfront fees you pay. The part that I agree with the most with this post is the complexity. It has the flavor of a whole life/VUL policy. Thanks for the post again!
Good post. Was starting to think WCI was making commissions from selling reverse mortgages. 😉
A reverse mortgage doesn’t really move the needle for a doc, but I’m sure it moves the needle tremendously for a dear old mother, grandmother, aunt and uncle, and help them stay independent.
I would be wary of kicking money to a parent in expectation of receiving their home one day. Time passes and things change. Next thing you know, years pass and they’ve sold the house, reverse mortgaged it anyway, or changed the will to leave everything to that lazy opportunistic cousin of yours. Or they go into the great beyond with a little home equity, a mountain of credit card debt, and a really great commemorative plate collection from QVC, and the creditors leave you with the scraps.
Easy for us because my husband’s an only child, and my parents have spared me any concerns by being poor, but why not give parents a formal mortgage/ buy the house from them rather than just kick them money? We bought his parents house from them once to facilitate their moving to a new one (and would have done even better had we moved into it as planned, until the Army changed where their aerospace medical residency is so we just ended up renting it out for a year and then selling).
In my 50s now the email and mail near scams I receive make me terrified for what must be bombarding even older folks constantly. Not worried about my not so well off older generation relatives, I’m already telling my kids that in 10-30 years (and they need to decide when) they perhaps should be screening all my mail/ email/ cold calls for me to protect me from things like ‘this is a bill you forgot to pay, go on and mail us a check for $349 every month’ sort of stuff let alone charity requests that might deserve much more scrutiny than they might get.
What you described sounds like just buying a house from parents who moved out. No big deal.
Buying or putting a mortgage on your parents house while they intent to keep living in it for the rest of their lives is a completely different story. Best case you’re giving them an interest-free loan and worst case you’re setting them up to screw you over by having to pay property tax, insurance, maintenance, utilities for the rest of their lives too.
If it works for someone’s particular situation, great, but I’d never want to own or be a lienholder on a parent’s house.
You also have the issue of losing the step-up in basis at death.
Yes! And when grandma bought the house in the 1960s, 70s or even 80s, your basis is virtually zero.
We own my wife’s parent’s home, along with her parents. We wanted to move them out of a dicey neighborhood. There are some states with programs that help protect all members of the family.
Under the terms of the state program we utilized, all 4 of us are on the deed, and none of us can be removed from the deed until we pass away or the house is sold. Nobody on the deed is allowed to transfer their interest in the home to anybody else. The parents have primary rights, so they can live in the house for as long as they desire (yes, some kids boot their parents after convincing them to transfer title, despicable as that is), but cannot sell it without our agreement. Title transfers fully to us when they pass.
The main drawback to this plan is the inability to refinance. With a rate around 6%, which was decent when we bought the house, well, we ended up doing a refi on our own house, and drawing out enough money to simply pay off the loan on her parent’s house. I don’t recommend that as a strategy… but in this case the loan principle was only about $60K, and we felt it was very manageable to add to our existing home loan.
Another drawback is no step up in basis when they die.
It’s cool how you published the point/counter-point format. Very informative. The biggest point for me is that it would be such a small increase in my wealth that it wouldn’t be worth it.
Totally agree with this article. So many potential pitfalls with a reverse mortgage and it seems riddled with extra fees and high interest rates.
I think a regular HELOC would be a better choice for most elderlyw high income individuals. If you live in an expensive house in a high tax state, you could take out $1M in equity and deduct the interest payments. A HELOC should also offer a lower interest rate and fees.
Not sure I agree. If you’re going to borrow out your home equity to spend, I suspect a HECM is going to be better than a HELOC. Similar rates and fees but with more features (and a few more downsides.)
Well written article. Good points!
Aside from the other drawbacks, the variable interest aspect itself is enough for me to walk away. It’s bad enough with short-term notes, but I really can’t imagine being saddled with a variable rate long-term note that is extremely difficult to pay off without dying or selling the underlying asset.
Is the HECM secondary to the primary mortgage like a conventional 2nd mortgage or HELOC?
Well, your intention when you take it out must be that neither you nor your estate expect any value to be left when you move out. So if getting perhaps 52% of its value plus being able to live in it mortgage/rent free until you cannot any longer isn’t an attractive trade to you, then don’t make it.
The HECM replaces the primary mortgage if you still have one. If the house isn’t paid off when you take out the HECM, then you can’t take as much out. So if it was only 75% paid off, perhaps the value you can extract is only 25% of the value of the house instead of 50%.
Ah, I didn’t know about the requirement to pay off the primary mortgage with the HECM funds.
For anyone still carrying a balance, that probably means replacing an affordable mortgage with something much more expensive. The justification for higher rates and fees on 2nd and 3rd mortgage has historically been the higher risk from the primary lien holder foreclosing after default. It doesn’t make any sense for the HECM lender to get all the extra benefits that come with additional risk when there is effectively no risk at all to making the loan.
Basically, HECM is simply an expensive mortgage with 100% deferred interest and a single balloon payment that the value of the home might not even cover. It’s not meant to be paid off. I’m not even sure the term “loan” is appropriate given that death is the best exit strategy from this product. The house had been effectively sold regardless of who holds onto the actual title.
Chris- I would argue you have not effectively sold your home with a reverse mortgage. You can sell the home, refinance the home, you can change directions anytime. There are no handcuffs with the HECM, it simply gives you more options and flexibility if the circumstances of your retirement need them.
I would propose another perspective and I believe you are missing the bigger point. Yes you are accurate in that the borrower is deferring interest and losing equity in the home with a reverse mortgage (same as any mortgage – the payment to pay a forward mortgage must come from somewhere, thus the estate is losing equity). With a reverse mortgage you are not making a mortgage payment anymore. So what happens to money that you would have used to make a mortgage payment for the next 15 to 20 years?
Well if you are still working, you can invest those funds elsewhere. If you are not working, you can delay taking Social Security, or reduce the amount you draw down on retirement funds. It is likely the former two options would reduce your tax rate while in retirement, thus extending retirement longevity because you don’t need to draw enough to survive and to pay the taxes.
What if as you were preparing to retire, the stock market entered and extended bear market? If your current retirement holdings drop by 25 to 30% how much does it cost you to liquidate those shares as opposed to allowing the market to recover before you commence drawing them out?
Let’s say your $600k retirement home was fee and clear and you opened up a reverse mortgage with no draw, you just wanted a line of credit as opposed to a home equity line. We just did a proposal for a client in this situation, his initial principal limit was $345,600 and his total closing costs were about $6,300 (including title, appraisal, etc.) or roughly 2% of the initial principal limit.
Here’s the big difference with the HECM reverse mortgage and a HELOC (home equity loan) – the HECM line is guaranteed to grow at the rate of interest until the last living person on the loan dies. I can’t remember this client’s age but let’s assume they were 65 years old and he believes he or his wife have a reasonable expectation to live another 25 years. The line of credit compounded at the rate of interest (5.015%) over 25 years grows to $1,184,336.60.
This line cannot be cancelled. If the property value drops in half, the line keeps growing every year. The client does not ever have to use the line, if they do not, they will be charged no interest as they paid their closing costs in cash.
So here is their plan – to live long with minimal financial stress. If the stock market crashes, he worries less, he will not withdraw from retirement funds, he will make withdrawals from the line of credit that year or those years.
He sleeps well because he has the option to draw upon the line of credit if he ever needs it.
If at the time of death, the line of credit has grown to $1.184M and the home is only worth $1M, they can write a check out of the line and use the full amount of the line at that time. The reverse is a non-recourse loan, meaning there is no deficiency claims against the estate, the property is the only collateral for the loan. If the home is worth $1.5M, then the kids sell the home, payoff the HECM, and the estate keeps the rest. Now assuming that he used the line wisely, it is reasonable to assume his increased retirement assets could equal as much or more than, what he has accrued in interest.
It is not a zero sum game. He moves equity from the home to offset other expenses that would have come out of retirement investments or to free up cash for alternative investment; the HECM affords you options – guaranteed for the life of you and your spouse.
My point is, there is a tsunami of retirement age people who are not as financially secure as many of you will be at that age. This is an option to give many of them piece of mind and if you read my article posted in yesterdays blog carefully, I think you will be surprised with the advantages. If you don’t like my article, you can read Wade Pfau’s book, it is excellent even if you don’t like reverse mortgages, and it’s a great education on the draw down of retirement assets and risks involved. There is also a TON of information and educational videos available on our website.
There is a ton of advertising videos on your site that promote a product you wish to sell. Not really educational.
He summed it up fairly well.
It won’t effect me a bit if stocks drop at my retirement since I have bonds. Nobody is recommending 100% stocks at retirement.
Given the costs, high interest rate which is variable, and the fact that you can only tap a portion of the home value and not all of it, makes the fact that the credit grows a very minimal benefit. It’s just like the WL promoters who pretend that dividends make it such that the growing loan balance isn’t an issue.
Oh come on Rex, that’s a little harsh or you’re missing how the put option works. Here’s how it works:
1) Sign up for the HECM and pay the initial fees (the cost of the put.)
2) The amount available to borrow now grows at a certain rate that has nothing to do with the value of the property.
3) The property value decreases or increases at a rate lower than the amount available to borrow.
4) The amount you can borrow out becomes worth more than the house.
5) You exercise the put and walk away with more than the house is worth. If 4 doesn’t happen, you never do 5 and all you’re out is the initial fees for the HECM.
Clearly a reasonable use of a HECM.
As far as using it to make retirement spending more efficient, I’ll refer you to Pfau’s excellent book on the subject. But the bottom line is having the option to borrow against the house in the event a bad sequence of returns shows up can allow you to hold more equity in the portfolio and increase both how much you can spend and how much you leave behind to heirs when compared to a less aggressive portfolio. The devil is always in the details and it might not really be enough money to move the needle for you or I, but it’s not a crazy thing to do.
Like you mentioned you can only access about 52% of the value at best. Whats really the chance the value of the house decreases and stays decreased for a time period where you would have otherwise sold the house such that this is a steal of a deal bc in essence you “sold” the house for more than its worth? Not much. Chances are super high that the amount one could loan is NOT greater than the house value.
Also as you mentioned, it doesnt move the needle for most people here but yet this is exactly who they are targeting. Why is it that Pfau uses 25% for taxes like you mentioned? I dont have a problem with an “insurance” plan for those who really are on the cusp of not safely making it. There is a cost to that insurance and those people may just have to pay that.
So why not just take that 6-7k original cost (not even factoring in loan interest) and invest it instead? You dont have to deal with the variable loan rate which could become a real devil later on once you have accessed the money.
Right on, hit the nail on the head. With 52% home Equity value, chances of exercising that put options sounds like a great depression., right after the company providing you the loan have filed for chapter 13.
Still a nice option to have. If it were free would you take it? Of course. So it has some value. You just have to decide if the value is more than the price.
You are being very generous. Its a pretty bad value. Normally you use points to get a lower an interest rate. But here we have in essence a situation where in essence you pay OVER 2 points just to guarantty a loan of 52% value that maybe you might excise the option on at a later date (assuming the company doesnt go under) and not at a lower but a much higher rate for those over 2% and variable rate they can skyrocket to boot. Again if someone really needs this level of insurance, fine, but for the docs looking to do well financially, this is a product with little new to it. I cant see why you are supporting it (for anyone other than who needs this level of insurance). You clearly have looked at the drawbacks which are numerous. The people pushing this get a cut of that 6-7k (and i wouldnt be surprised if that were a cherry picked low number) and arent going to be around decades later to help you with the variable rate you signed up for.
I’m very much aware of the downsides and don’t anticipate that I’ll be buying one. But I think there will still be some people who look at that and say, “You know what, the upsides are worth the downsides to me.” Obviously you’re not going to buy one. Obviously it costs more than a typical mortgage. But you know what? Try getting a HELOC when you’re 62 and don’t have a job. Plus you get some guarantees that you don’t get with a HELOC or other more typical mortgage. Not to mention the person who just wants to maximize their spending and has no desire to leave a legacy of any kind. I mean, imagine someone with a net worth of $1M with a $600K paid for house. A HECM may double his retirement spending. There’s a market there for this product and it isn’t composed of entirely stupid people.
This is actually the 3rd time ive mentioned it but no problem with the people who NEED the insurance. Insurance can be expensive (very expensive in this case). This series was really about marketing it to docs as a smart move and in that situation, anyone following the typically boglehead approach, then yea you can start using the word stupid.
I disagree. Lots of Bogleheads buy SPIAs, and many of those might find a reverse mortgage useful too.
But there’s no way for either of us to prove the percentage of “smart” people who would find one of these useful. It’s clearly not zero. Nor is it c100%. In between those, there’s plenty of room for reasonable people to disagree. It’s mostly all academic anyway, since you and I aren’t going to use one. But I’d let someone advertise them on the site, unlike whole life insurance. It’s smarter than a lot of things people do while trying to get more income out of their nest egg.
“If at the time of death, the line of credit has grown to $1.184M and the home is only worth $1M, they can write a check out of the line and use the full amount of the line at that time. ”
I’m confused. If they’re dead, who is writing the check?
What happens if a living owner-occupant is underwater on the house, and needs to go into assisted living, or just wants to sell and go?
Thanks for these posts, although I admit I am still a bit unclear on all the permutations
My impression is that the most common “good” use of a reverse mortgage is to take out a line of credit early (say 62) and let it grow over time as a protection against running out of money (sequence of returns risk, etc). In this case the only downside risk is the various costs with establishing it and any yearly fees.
Until you take a withdrawal there should be not cost, correct?
Last line should be “should not be any additional costs, correct?”
Right, other than the initial fees. That’s what Pfau is advocating for.
An extra comparison, atop the example in the “You Only Get To Use …” section. $500k house providing $1498/mo is a yield of 3.5%. There’s dozens of blue-chip and S&P-500 stocks paying dividends at that rate or better, including oil majors and utilities which have exceeded that yield for decades now.
So, you can better the loan, purely on yield, by a dividend-stock portfolio serving as your own private annuity. Setup is far simpler. I’m far away from having to consider taking a reverse mortgage, so I have time to provide myself with something that’s not-worse on all aspects I can come up with. Ergo, building out such a portfolio bumps a reverse-mortgage off my list of possibilities in my financial plan.
Interesting way to look at it. The “products” are so different though, I’m not sure the comparison is apt. Different benefits, different risks etc.
Informative series this week. Good to learn about the options, limitations, and read some discussion. Thanks for the detail.
The only scenario where I see the HECM as beneficial is when someone has lots of high interest debt (credit cards) and a mortgage that they can’t make the payments on. The HECM will eliminate the debts and allow the homeowners to stay in their home.
That would be a great thing for my spendthrift relative, except he knows his mortgage banker better than he knows his retirement fund manager and has already maxed out his home equity loans. So far at 80 it hasn’t cost him but the piper will be paid, probably not by him but by his wife who is 18 years younger. She married a rich man and he never taught her that you can’t spend more than is coming in forever. We’re kind of angry that he won’t be around when she has to learn that firsthand.
“So when you sign-up for a reverse mortgage, you are committing to a high-interest rate, non-deductible, variable rate loan. That sounds kind of bad when you put it that way, doesn’t it?”
I just wanted to point that this is how home mortgages work in nearly every country on earth except the US. Just because it is different from how American mortgages work doesn’t make it a bad deal. (After all, people buy houses under those terms every day in large numbers.) It seems like you’d need to argue that on the merits rather than just say it is different.
I’m certainly not an expert on global mortgage trends, but here in the US, a mortgage is typically at a low fixed interest rate that is often deductible.
Thanks for pointing out the obvious discrepancy between real and imagined tax rates for retired folks. I basically pay about 2% average tax rate on my income – and we (married filing jointly) have nearly 40K of annual income. With little to no housing cost and a paid for auto – that 40K goes a long way. that 2% tax does however arise from a 22% marginal tax rate – 15% bracket with 50 cents of SS benefit becoming taxable on the next dollar of taxable income.
A low taxable income has its advantages!
Discussed reverse mortgage with husband as the articles came out, and we decided at likely 50% pay out of home’s value we can just go with the “We buy cheap houses” guy at hopefully 60%+ of value, or even sell for 80-90% if we have a few months.
You’re comparing apples to oranges. With the HECM, you get the money and you get to stay in the house. And your heirs might even get some money left over. If you sell it to the “we buy cheap houses” real estate investor, all you get is the money. You still need somewhere to live.
No im pretty sure she also has this pegged, If you have purchased this option and allowed it to “grow” then you are much closer to death at that point or the nursing home and thus the additional housing costs arent as much a factor. If you exercise the option early on then you are paying a truck load in interest along the way. Its actually such a bad deal ill predict this topic will be covered again with a version 3 of reverse mortgages that is branded as totally different then the first and 2nd versions.
I think you’re overreaching with describing it as always a “bad deal.” The value of the home and the amount you can borrow against the home grow at different rates. That’s what allows the possibility of using it as a put.
The annuity feature also has value. Once the housing/spending value you’ve sucked out of the home exceeds the value of the home, you still get payments and get to live in the home until you die.
Do these guarantees come at a cost? Yes. Is that cost too high for you and I? Probably. Will the amount you can borrow move the needle for you and I? Probably not. But we’re far more anti-insurance/debt and far wealthier than the average doc, much less the average American.
http://www.moneysense.ca/invest/the-mortgage-that-grows
I hope you can open this very informative Canadian article.
Anything in particular about the article you would like to point out to readers?
Keep in mind that the Canadian model does not have the growing line of credet of the HUD back HECM loan
I don’t like the fact that the taxpayer is subsidizing reverse mortgage loans, AND the borrower must pay PMI.
I don’t think it is logical to pay points to get a mortgage, then pay more points to eliminate it with a reverse mortgage at a higher rate. This sort of thing should be illegal.
If I get the line of credit at age 62, and allow it to grow until I am 75 –well, tapping the line of credit is a commitment to remain in the house, precisely when I am probably looking wistfully at the senior living center. So the ‘growth’ option isn’t that valuable.
It’s interesting to see yet another scam by big business and the government that appears in every way to be protecting the consumer but in actuality turns out to be just the opposite.
So in our case 100% equity in a property worth $130,000 would end up providing us with $8000 cash.
That was an eye opener. The government would “protect” us by requiring we put most of the loan in an account to pay the taxes, insurance and whatever else for the rest of our life. That way we wouldn’t lose the “benefits” of the loan by losing the house prematurely. Thanks government! You’re wonderful for protecting us! But wait. Doesn’t that actually protect the lender by making sure there is absolutely nothing due when we croak? No outstanding tax liability no liens, no loss if the place gets blown to Oz in a tornado? I assume they’re not gonna write the insurance check out to us so we can build a new house next door to the Wizard…
This is perfect example of a bad credit score being an asset. Thanks guys!
Your article lays it all out in understandable easy to read simple English but there’s nothing like reality to bring it home.
The only way I really got it was by checking it out myself. From now on it’s either the casino or bitcoin. At least I know where I stand there.
Thanks!
Me
That’s really bizarre. I would not expect only $8K from a $130K house. Sounds like a particularly bad reverse mortgage to me. Surprised it is even legal.
This is not a HUD backed HECM loan
Our house is worth about $625K. It is free and clear. I am 69, wife 68. We got a quote on a RM and the amount available is only $201K. A few years ago we were told it would have been $378K but the lending amount has been reduced by HUD. At $378K it would be worth considering but not at $201K.
Wow, less than 1/3. Hard to get too excited about that.
“The Required Minimum Distributions (RMDs) for $1 million at age 70 is $36,000 a year.” Should this be updated ? Great and informative Article.
Is it no longer correct? It was the last time I looked. What do you think the RMD is for a 70 year old?
It’s actually $36,496 if you want to get really specific. More info here:
https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf
I believe Drex88 is referring to the SECURE act change that pushed the RMD age out to 72 (for now).
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
Oh, of course, you’re right. Yes, that should be updated.
At 72 the RMD is a little higher too, about $39,000.
Please tell us what can be done and the least cost so tha I can stay in my mom’s home. She does not have a lot of equity but she wants it now to stay in the family. Should she try to refinance back into a mortgage?
You’d have to contact the lender and get a buyout price of some kind. I bet it won’t be cheap.
At the minimum you can make a voluntary payment towards the reverse mortgage
This will reduce the negative amortization .
Keep in mind that this is a non recourse loan and regardless of what the loan balance is the hiers will be able to settle the loan for 95% of the appraised value.
Another option you will have is to keep the loan balance low (by making voluntary payments towards the R.M) this way when the homeowner passes away you can remain in the home by refinancing the reverse mortgage with another reverse mortgage in your name.
I don’t see many people talking about the HECM guaranteed growth rate feature on the line of credit. From my limited understanding, the line of credit would grow over time by the amount of the interest rate plus a mortgage insurance premium (MIP) rate. A hypothetical $350K line of credit today could grow to $450K in 5 years or >$550K in 10 years ( assuming a rate was 4.50% + MIP 0.25%).
Certainly there are costs available to obtain such a feature, but in 5 or 10 years the LOC would become very valuable to an older couple whose options decrease later in life to obtain credit.
This comment is for Linda Flores (See Linda,s post above)