My Two Cents

Reverse Mortgages

Chris Farrell Apr 26, 2007

We’ve been getting more and more questions about reverse mortgages.

A quick reveiw: With a reverse mortgage you get a loan against the value of your home. The maximum amount you can get comes from a combination of your age, the Treasury bond rate, and the value of the home.

The lender can pay you in a lump sum, a regular monthly check, or line of credit (or some combination of these choices). You’re spending down the equity in your home to boost your income. The loan gets paid back when you sell the home, permanently move out, or die. To get a reverse mortgage, you need to own your home, and be at least 62 years of age. The AARP offers basic information on reverse mortgages, as well as a reverse mortgage calculator.

Reverse mortgages are a smart idea for an aging population with high rates of homeownership. But it’s a complicated product and fees are high. Here’s an example: Take a $200,000 home between 1975 and 2005. Assume that the same reverse mortgage product was available throughout that period of time. The amounts a 65 year old could have borrowed on a $200,000 home during that period ranged from 4.8% of the home’s value in 1981 to 51.3% in 2002. One trade-off seems to bother a lot of parents: In most cases, a reverse mortgage means the kids won’t inherit the home.

The good news is that the business is getting more competitive, it’s growing, and fees are coming down. It’s still a tough product to grasp, but I’m seeing much more focus on education and standardization.

The Federal Reserve Bank of Boston has an analysis of how to think about including a reverse mortgage into an overall portfolio.(I took the $200,000 home example between 1975 and 2005 from their paper). It isn’t an easy paper to get through.

Still, the authors note that the most popular option when it comes to taking the money in a reverse mortgage is the line of credit. But they argue that under most assumptions the optimal strategy is to take a reverse mortgage in the form of a lifetime income at age 65. In essence, a reverse mortgage acts like a very safe annuity for the homeowner.

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