Reverse Mortgages: Opportunity and Risk

(This is a transcript of Doug Keegan’s [i]Making Cents[ei] segment heard every month on [i]Lincoln Radio Journal[ei]. [L=url]www.lincolnradiojournal.com[EL]

Q: We’ve been focusing on debt-related topics since we started the Making Cents segment. In fact, today we’re going to talk about reverse mortgages, another debt-related topic. Why the focus on debt?

A: Because debt is the elephant in the room that no one wants to talk about. According to consulting firm McKinsey, between 2000 and 2007, Americans doubled their debt to almost $14 trillion, with personal consumption accounting for 77 percent of real U.S. GDP growth. At the same time, despite consumption on steroids, the stock market has gone nowhere and home prices have imploded. So now when people take a look at their personal net worth, they see their debt as a higher percentage to their assets and they get scared. And that’s why I have been covering debt-related topics. The rubber has met the road and people get it. They intuitively sense that they have to take control. That means spending less and getting out of debt. And the research shows it. The same McKinsey report says that beginning in 2008, for the first time, Americans finally started reducing their debt. We went from a negative savings rate a couple of years ago to a plus 5% as of January this year.

People want to know how to get out of consumer debt, how to monitor and build their credit score, how to restructure their mortgage debt, how to pay for their kid’s college, how to get bargains, how to reduce their taxes, all in an effort to spend less and save more.

Let me give you the numbers. McKinsey developed something they call their retirement readiness index. A score of 100 means you’ve saved enough. A score of 80 or lower means you haven’t saved enough and you’ll need to reduce your spending in retirement. Currently, the average American household has a retirement readiness index of only 68. We’re not ready. To quote Mark Twain, Denial ain’t just a river in Egypt.

And this will have a huge impact on our economy and the stock market. If we spend less, our economy won’t grow as fast. That means lower stock market returns. With lower stock market returns, you’ll need to save more.

And if that wasn’t bad enough, we have a federal government that is intent on going broke. The White House recently said it’s predicting a 10-year federal deficit of $9 trillion. And that’s just what we’re taking in and taking out each year, it’s not our national debt. By 2020, our national debt will equal ¾ of the entire U.S. economy. How can you grow an economy when ¾ of it is tied up in debt? You can’t. So Americans are concerned that the federal government will raise taxes and cut benefits. That further puts pressure on how much Americans can save for retirement. Americans intuitively sense this and they want answers. And I want to do my best to help.

Q: So let’s get to our topic, a reverse mortgage. You say that there has been some shenanigans going on with the sale of reverse mortgages and that seniors, the age-group that buys reverse mortgages, need to be particularly wary. Can you explain?

A: A reverse mortgage, just like any other financial product, has its place. It can be a viable retirement planning tool when used appropriately. So I’m not here to bash reverse mortgages. I am here, however, to caution seniors. Please, please be wary of anyone trying to sell you an annuity or a life insurance policy with the lump sum proceeds from a reverse mortgage.

Let me explain. Reverse mortgages have been around for nearly 20 years, but it wasn’t until the recent financial crises that they caught on. So some seniors, who have found themselves in a situation where they need extra cash to pay their bills, are considering a reverse mortgage. And like I said, a reverse mortgage can be a viable alternative. However, with this increase in demand, combined with an elderly age-group desperate for a solution, we are starting to see some abuse and outright fraud, not only committed by mortgage brokers, but as well by insurance agents. And this is where you have to be careful.

This past June, the U.S. Government Accountability Office released a report citing recent cases in which reverse mortgages were sold to seniors to get them to inappropriately invest in annuities. For example, in Maine, an insurance company sales manager arranged for a reverse mortgage lender to speak with his sales force. They later referred 14 clients. All obtained reverse mortgages. One 81 year-old widow was sold a deferred annuity that earned only 3.25% interest, purchased with her reverse mortgage, which charged a little over 4%. So she paid 4% for the privilege of getting 3.25%. That doesn’t sound like a good deal to me. Under the Housing and Economic Recovery Act of 2008, a lender, or anyone else, cannot require a reverse mortgage customer to purchase an annuity as a condition for buying a reverse mortgage. But despite the law, it’s still happening. So be cautious.

Q: What is a reverse mortgage and how does it work?

A: If you’re over 62 years old and own a home with little to no debt on it, you can do a reverse mortgage. Unlike a traditional loan, there are no income or credit-score requirements, and you can use the money as you wish. As part of the economic-stimulus package, you can now borrow up to $625,000 through the end of this year. After that, it reverts to $417,000.

A reverse mortgage is the opposite of a mortgage. Instead of you making the monthly payment to the bank the bank makes a monthly payment to you, tax-free. You get a check in the mail every month and the amount you receive is based on your age and the value of the home. The bigger the value of the home and the older you are, the bigger the monthly check. And you’ll continue to get these checks until you die or move out. At that point the loan has to be repaid by selling the house. Instead of a monthly check, you can also get a lump-sum or a line of credit. The lump sum gets you the cash immediately.

As a rule of thumb, a 75-year-old can borrow about 45% of their home’s value. So if their home is worth about $250,000, they can get $110,000 as a lump sum or $900 a month.

Q: Who should consider a reverse mortgage and are there any other alternatives?

A: Lowman, people get reverse mortgages when money is tight. It’s common for those who have no other resources. So it can really help people who absolutely need the money. Think of situations like long-term care expenses or someone in their early 60s who just got laid off and can’t pay their bills and may be facing foreclosure. So in those and similar last resort situations, a reverse mortgage can really come to the rescue.

It can also help in situations when someone is house rich but cash poor. In that situation, a reverse mortgage may provide the additional monthly income they need to stay in their home.

But if you’re looking to generate a couple extra dollars in retirement for discretionary expenses, I don’t see it as a good option. In my opinion it’s still too expensive. On a $200,000 loan, the upfront costs could be as high as $20,000. So try everything else first, including a home equity line of credit or refinancing. You may even want to look at selling your home. But you know Lowman, selling a home is an emotional issue and many people just don’t want to go there. The sad truth is they could be just delaying the inevitable. That’s why it’s so important to hire a financial planner who, for a fee, can objectively help you sort through your options.

If all else fails, buy a reverse mortgage but make sure you shop around for the best deal and please stay away from people trying to sell you something with the proceeds.