Learning about reverse mortgages
A question we get all the time is from home owners eager to pay off a mortgage early. I think it’s financially critical for homeowners to enter their retirement years debt-free, including the mortgage. My main caution for younger owners involves diversification. I think most people should focus on building up their retirement, emergency and other savings before getting too aggressive with the mortgage pay-down. You don’t want to put all your eggs in one financial asset — a home.
However, it’s sensible to focus on paying down the mortgage once you’ve managed to create a well-diversified savings portfolio, especially as you get older. Both financial security and psychological security come from living debt-free.
Certified financial planners are skeptical about the wisdom of paying off the mortgage for their wealthy clients. A home is where the client lives. Wealthy clients can earn a much better return on their money investing in assets other than the home. The Journal of Financial Planning has an intriguing article by Ed McCarthy on homes and wealthy clients. He lays out the typical objections by CFPs in Housing: A Potentially Active Player in Client Wealth Strategies. McCarthy accepts the traditional CFP insights, but he’s more empathetic to the notion of eliminating the mortgage.
The most intriguing part of the article for me is when he highlights reverse mortgages. I haven’t been a fan of reverse mortgages, although I’m glad the product exists. The main advantage of a reverse mortgage is that the homeowner gets access to their home equity without moving. A reverse mortgage allows anyone 62 or older to borrow against their home’s value. A homeowner makes no repayment until the house is sold (typically after death). Money can be taken as a lump sum, a line of credit or a regular payment schedule. If you like the idea of staying in your own home — and are struggling to find investments with safe, stable income streams — you should learn about reverse mortgages.
The problem with reverse mortgages has been their complexity and their high cost. McCarthy quotes from the CFP John Sestina to describe the steep fees associated with the product.
John Sestina, CFP®, ChFC, president of John E. Sestina and Company in Columbus, Ohio, cites an example of a reverse mortgage borrower who qualifies for a 4.2 percent loan rate. “By the time they go through the FHA’s HECM (the Federal Housing Administration’s Home Equity Conversion Mortgage program), the rate goes up to about 6.2 percent. Then they’ve got the monthly service fee of about $30 and the upfront set-aside fee, which is about $4,000. There’s an upfront loan origination fee of about $6,000. There’s another upfront fee for mortgage insurance of about $9,000. Then there are other closing costs, of course, of about $3,900. So you’re looking at maybe another $20,000 that is added to the cost. And, of course, the cost is added to the mortgage amount, and the interest that is calculated during the term of this program is being paid on this additional cost.”
Thing is, the product is improving, says McCarthy.
Sestina raises valid objections, and his comments are representative of the arguments against reverse mortgages, but several developments could increase reverse mortgages’ acceptance among advisers. First, the FHA introduced the HECM Saver reverse mortgage in September 2010. The product offers lower upfront costs coupled with lower lending limits.
The cost of the reverse mortgage is heading in the right direction, although more progress is needed. It’s still a complicated product that shouldn’t be taken on without a lot of research and sound advice.
I still think, for most people, it’s an option that exists far down the list of potential ways to raise money. There are other ways to unlock value, such as moving into a smaller home. In essence, it’s really an insurance policy for aging homeowners. Like annuities, long-term care insurance, and a number of other products designed for the retirement years, a reverse mortgage is well worth watching and researching the trade-offs.
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