There are some financial products out there that really get my hackles up. I’ve talked previously about my loathing for different types of annuities, for example. Products like these are said to be “sold and not bought” because anyone who went looking wouldn’t choose to buy due to the product’s complexity, lack of transparency and high cost. So, to get investors to buy, the products need to be sold by a slick salesperson who pockets a fat commission at the end of the transaction. This is an age-old problem and won’t be going away anytime soon.
Another product like this is the reverse mortgage. Just uttering the name causes a visceral reaction as I recall stories from folks who got swindled by clever salespeople. But as a fee-only planner charged with ensuring my clients accomplish their goals, I have to be open to investment products that may once have been anathema to me. In other words, I can’t continue to reject a product because it was bad in the past. It’s hard to say it, but the much-maligned reverse mortgage may be making a comeback.
The reason, as I see it, has to do with several factors. First, more Americans are retiring with insufficient cash and investments to cover their needs for what they hope will be a long retirement. The asset they do have, however, is the equity in their home but with limited ways to access it.
Second, expected returns from stocks and bonds are lower than they’ve been in the past. Interest rates are low and so is inflation. This makes it challenging to “lock in” higher interest rates on longer-term bonds, for example, to help fund retirement. Folks understandably look at CDs offering near 3% for a few years and compare this to a 30yr Treasury bond paying the same rate. It’s a no-brainer that many pick the short-term CD.
This leads to the third factor helping bring reverse mortgages back to the retirement planning toolkit: short-term thinking for a long-term problem. As investors focus more on short-term yields, they forget they probably need higher returns to meet their long-term planning objectives. A CD may sound appealing and “safer” but not if you need to average, say, 5-6% over time to ensure you don’t run out of money. If some are intent on having less exposure to stocks and bonds, they’re going to need to get creative with other income sources to help fill their personal performance gap.
The fourth factor is recent favorable research about reverse mortgages and enhanced regulation making the product more accessible. Here are my thoughts about leveraging reverse mortgages:
The Pro’s –
Getting a reverse mortgage allows you to pay off your existing mortgage without needing to make monthly payments. This is obviously a huge benefit for retirees without enough cash and investments to see them through. Having a smaller monthly “nut” allows savings and investments to last longer and increases options in the future.
Additionally, since most borrowers can access 60% or more of their home’s value, whatever they don’t use to pay off an existing loan can be set up as a line of credit. This could be accessible as needed and wouldn’t require monthly payments either. This helps, for example, when the stock market is down and you need extra money. Maybe it’s a new car, home maintenance, or even in-home healthcare during one’s later years. Instead of selling stocks you’d simply access your line of credit. When stocks recover you could backfill what you borrowed by repaying some of the loan or let the growth accumulate.
These benefits would let the retiree “age in place” for as long as possible, ideally to the end of life. National polling indicates this is the preferred solution for most people, assuming they can afford it. If reverse mortgages help accomplish this, so much the better.
The Con’s –
Probably the most important con is that the retiree is giving up options when they take out a reverse mortgage. How so? By borrowing money against your home’s equity and then not making payments on the debt, the interest owed simply piles up. Over time this will mean less equity to help with relocating (if needed), future borrowing, leaving your home to family, and even moving into assisted living. (If the borrower doesn’t live in the home for, say, six months or more, the lender can call the loan.)
The other major issue with reverse mortgages has to do with cost, both on the front-end and during the life of the loan. While costs have come down with more government regulation, upfront costs can still run thousands and ongoing costs are typically based on adjustable interest rates. This makes me nervous since we expect rates to rise over time, which would cause home equity to get soaked up at an ever-faster rate. One positive is that some lenders are offering fixed-rate alternatives in the 5-6% range. These come with restrictions and are best used when the borrower is paying off their current loan but, in my mind, adds a positive asterisk to the negatives.
In summary, reverse mortgages have some redeeming qualities and, for a growing number of Americans, will be an important tool to help them live a long, happy retirement. But they are not right for everybody and the devil is in the details. Just to be clear, as a fee-only planner I don’t make a dime if a client gets a reverse mortgage. What I can do, however, is help determine if doing so makes sense.
Should you have questions about your situation and if a reverse mortgage might fit, please let me know.
Have questions? Ask me. I can help.
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