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REVERSE MORTGAGES:
BENEFITS AND DANGERS
Introduction:
So, you are sitting
there with hundreds of thousands of dollars in equity in the home you
have owned for twenty years, are retired so you have fixed income,
inflation is eating away at your fixed income value, and you wonder how
you will meet your various bills or if you can ever afford that trip to
Europe you always wanted.
Then you read that
magically you can convert that large equity in your home into cash or
cash flow right now, that the pay back only is required if you leave the
home, sell it, or die, and that, at long last, you can enjoy the
benefits of all that equity in the home.
But…you have also
heard that these types of loans…called REVERSE MORTGAGES…have
dangers inherent in them, can be very costly, and read stories about sad
elderly persons bemoaning their decision to utilize reverse mortgages.
So, which is it? Are
they a financial tool that you can use to improve your life style or are
they a trap for the unwary resulting in benefit to the lender and
potential economic catastrophe for the borrower?
This article shall
discuss some of the benefits and perils of Reverse Mortgages and ends
with a checklist of recommendations that anyone should apply before
utilizing what can be a valuable tool for financial planning. Reverse
Mortgages are neither a panacea nor a fraudulent trap…but to be used
correctly require some forethought and some healthy skepticism as the
salesperson is extolling the benefits of this recent innovation.
The Basics: What Are
They?
When one borrows
money, one receives money and, in return, promises to repay it over time
with interest. See our article on
Promissory Notes.
Certain notes are secured by mortgages or deeds of trust which provide
that if you fail to pay, the creditor can foreclose on your home and
sell it, utilizing the proceeds to pay off the unpaid portion of the
Note. See our article on
Real Estate Transactions in California.
The Reverse
Mortgage, in concept, is simple. Instead of starting to pay off the note
immediately, payment is held off until you die or sell the home and the
note is paid off at that time. Thus, you get the money now, and the
accruing interest is simply added to the note to be paid in one lump
payment when you leave the house. You get a large chunk of cash now to
utilize for whatever purpose you wish or to invest and no payments are
made to the lender until you have liquidated the home and the payments
are paid from the excess equity in the home.
Are they popular?
Reverse mortgages in
2007 had become a twenty billion dollar a year industry with elderly
homeowners borrowing more than one hundred and thirty two thousand of
such loans in 2007, an increase of more than two hundred and seventy
percent from two years earlier. As more and more homeowners become
elderly with fixed incomes, this tool will become more attractive.
But there are
problems.
The Usual Complaints.
-
Expense:
These loans are often extremely expensive, such expense “hidden”
since most of the repayment does not occur until the house is sold.
Variable interest rates are often used that start out low but
quickly accelerate to high or very high. Loan origination fees,
often deducted from the sums paid to the borrower, can be extremely
large, often as much as eight percent of the entire loan ($17,000 or
so for a $400,000 loan is typical.)
-
Pressure to Invest.
Many of the companies offering Reverse Mortgages are actually
interested in selling investment vehicles or annuities in which
sizable commissions end up in their pockets. Quite often the
salesperson establishes a close and friendly relationship with the
borrower and then offers “safe” places to put the money, often long
term annuities which end up with the borrower only seeing a small
part of the “freed up” money and paying substantial fees to the
investment company. While the investment companies claim that they
do not pressure the borrowers to make such investments, law suits
claiming the opposite have been filed in many states.
-
Lack of Effective Governmental Control.
The Federal government does require that a “counselor” be made
available to the borrower before they can obtain the loan. It is now
apparent that most such counselors are actually paid for by the
companies selling reverse mortgages and the counseling is often not
only perfunctory but, as with all matters, the counselors are
inclined to recommend the loan since their monies come from the
companies offering the loans.
-
Bad Investment Decisions.
Once the money is in the hands of the borrower, it needs to be
placed in a safe investment. Without past experience in handling
such relatively large sums, the investments may be put out of reach
(long term annuities) or invested in high risk securities and many
of the people borrowing, grateful for the sums coming from the
Reverse Mortgage Company, listen to their advice or the advice of a
son in law and end up with much of the borrowed sums unavailable or
lost.
The
Usual Benefits.
-
Money. Now.
As one client put it, “Why keep all this wealth locked away in a
house for people to inherit after I am dead? I earned it. This gives
me a chance to live in my home, use some of my wealth right now so I
am not worried and the only real cost is paid from my wealth after I
am gone. What’s wrong with that? “
-
Better Return Possible.
Real estate is not always a good investment and, indeed, beginning
in 2006, became a poor investment. By taking out several hundred
thousand, one can shop around for investments that are more
valuable. (Careful here…once the cost of the interest and the cost
of the origination fees are considered, it is almost impossible to
conceive of a safe investment that could generate a real profit.)
-
Payoff of Higher Interest Loans.
If one is in debt on credit cards or other high interest costs it is
probably true that the Reverse Mortgage will save money if the
credit cards are entirely paid off and no further credit card debt
is undertaken.
-
Peace of Mind.
Many of the elderly live from paycheck to paycheck or on social
security, worrying about money all the time, worried about affording
medical care or even the smallest luxuries…yet live in a home worth
hundreds of thousands or more. A sensible use of Reverse Mortgages
allows access to cash, a peaceful state of mind, and that may be
worth it…IF the monies are used correctly.
Some
Basic Steps to Use Reverse Mortgages Correctly.
-
Get Outside Advice.
No
matter how charming the person offering the product or how many
multi colored brochures they bring, get advice from someone not paid
to “land the deal” before signing on. A good attorney or CPA should
be consulted before the first paper is signed.
-
Shop Around.
Many companies offer the product. Compare and contrast.
-
Do Not Invest with the Person Selling you the Mortgage.
Borrow from them if you wish but do NOT utilize their advice as to
investments. True investment advisors are available and well worth
your money. You want an advisor who is not paid by the company
offering the product but by you on an hourly basis. Using investment
advice from a person being paid by the company selling the
investment is like trusting a used car salesman as to the quality of
a car you are thinking of buying. Your CPA or attorney can give you
the names of appropriate advisors.
-
Use the Money Wisely.
You should use the sums to better your life and your feeling of
security. Yes, luxuries can be on the agenda…but make sure you do
not end up with the money expended on things that are not critical
for your own happiness.
-
Don’t Feel Guilty.
There is a tendency, especially among grandparents, to feel that
their assets are de facto the inheritance of the next generation.
They feel they should not “spend their children’s money.” It is not
their children’s money. It is their money, usually earned over
decades of hard work, and a correct balance between generosity and
living a decent life should be maintained. One client of our office
simply gave all her borrowed money to her son who promptly lost it
in stock investments. She would have done better to give him a
little each year and used the rest for her own well being.
-
Don’t Borrow If You Don’t Really Need It.
It’s not free money. Most of it is simply paid once you are no
longer in the house. Home equity is a valuable commodity and should
not be spent unless the difference in your life style will be
important to you.
Conclusion:
As seen in our article on
Elder Abuse,
there is a thriving industry that seeks to take advantage of the
elderly. Reverse Mortgages can be exploited for that purpose but they
can also be a valuable and important financial tool for those person who
simply use some common sense, get some good professional advice, and
maintain the discipline in its use that they used to amass the equity in
the first place. As with so much else, used in moderation and with clear
thinking, they can make life much better for many people. Just take the
time to carefully plan how the tool will be used…or if it will be used
at all. |
