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.
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.