Michael Evans
2/26/2006, 09:04 PM
The idea is simple enough. You have lived in the house for many years, and you have paid off the mortgage while watching the value of the house triple. Now that you are either nearing or actually in your retirement years, the bills start to mount much faster than the ridiculously understated cost-of-living increases in social security or, if you still have one, your pension payments. And oh yes, you meant to save during your working years but what with one thing and another, you only managed to set aside $23,000. What to do?
If your house is worth a substantial six-figure sum, one possibly is to sell it and live off the proceeds of that investment. But most people don?t want to move to reduced quarters, and would much prefer to hold on to the old homestead. Enter reverse mortgages ? the hottest new financial product on the market for Those Over 65.
Suppose your house is worth $400,000 and free and clear of all mortgages. Under a standard plan, you should be able to get a $300,000 reverse mortgage, which you can conservatively invest at 6% per year. Of that, $0,000 to $20,000 will usually go for fees. When you die, the lender sells the house and pays off the mortgage. Meanwhile, you live rent-free (except for taxes, insurance, and repairs, of course) and can enjoy your Golden Years more comfortably.
Now what could possible be wrong with that?
Of course, you would be spending the kid?s inheritance. But for some older folks, that?s no big thing. If this doesn?t bother you, there are relatively few downside risks. Yes, I know, the economy could go into another depression or interest rates could go back to 20%, but come on. Realistically speaking, inflation and interest rates are going to stay right about where they are for many years, and on average housing prices will rise at least as fast as the rate of inflation. If you want horror shows, you won?t find them here. Go rent the Texas Chainsaw Massacre Part IV.
The Federal government is all in favor of this scheme, by the way, because it reduces the number of poor sick people who will qualify for Medicaid. That doesn?t necessarily mean it is a good ? or a bad ? idea. It does mean that the government is encouraging financial institutions to make these loans available. So if you are interested, it is worth shopping around for the best deal, particularly on those up-front fees, because more and more lenders are now offering this type of mortgage.
Maybe by now you are waiting for me to drop the other shoe, so to speak, and reveal these mortgages as some sort of big scam, but if so, you will be disappointed. I have always thought that a long-term prudent investment strategy is, so to speak, to be overweighted on real estate. Over the past 50 years, the mortgage rate has averaged 1% to 2% more than the average annual appreciation in housing prices, but the homeowner gets the leverage from a 20% down payment plus ?inside buildup?, meaning you don?t have to pay income taxes on the gains as they are accumulating. That boosts the average annual gain from 6% to 12%. Even after paying 1% in property taxes and another 1% in insurance and repairs, the average annual gain on your equity is 10%, compared to an 8% mortgage rate (all these are long-term averages). Plus you get to live in the place.
I used to add some comment to the effect that another advantage is you couldn?t go to the bank and withdraw your equity buildup in the house easily, but that?s out the window these days with all the second mortgages and home equity loans. Which leads to the major problem of reverse mortgages ? many people have re-mortgaged their home so much that there isn?t much equity in spite of the rapid rise in prices. And if you don?t have much equity, the whole concept loses its value.
So reverse mortgages make sense only if you have no existing mortgage, or at worst a very small mortgage. Also, taking out a reverse mortgage at age 65 means you have immediately depleted your nest egg, and won?t have the increased equity to fall back on a decade or two from now. But increasingly, for people who are forced choose between losing their current home or not, reverse mortgages are quickly becoming the wave of the future. And as a result, the overall personal saving rate, which reportedly is already negative, will sink even further.
If your house is worth a substantial six-figure sum, one possibly is to sell it and live off the proceeds of that investment. But most people don?t want to move to reduced quarters, and would much prefer to hold on to the old homestead. Enter reverse mortgages ? the hottest new financial product on the market for Those Over 65.
Suppose your house is worth $400,000 and free and clear of all mortgages. Under a standard plan, you should be able to get a $300,000 reverse mortgage, which you can conservatively invest at 6% per year. Of that, $0,000 to $20,000 will usually go for fees. When you die, the lender sells the house and pays off the mortgage. Meanwhile, you live rent-free (except for taxes, insurance, and repairs, of course) and can enjoy your Golden Years more comfortably.
Now what could possible be wrong with that?
Of course, you would be spending the kid?s inheritance. But for some older folks, that?s no big thing. If this doesn?t bother you, there are relatively few downside risks. Yes, I know, the economy could go into another depression or interest rates could go back to 20%, but come on. Realistically speaking, inflation and interest rates are going to stay right about where they are for many years, and on average housing prices will rise at least as fast as the rate of inflation. If you want horror shows, you won?t find them here. Go rent the Texas Chainsaw Massacre Part IV.
The Federal government is all in favor of this scheme, by the way, because it reduces the number of poor sick people who will qualify for Medicaid. That doesn?t necessarily mean it is a good ? or a bad ? idea. It does mean that the government is encouraging financial institutions to make these loans available. So if you are interested, it is worth shopping around for the best deal, particularly on those up-front fees, because more and more lenders are now offering this type of mortgage.
Maybe by now you are waiting for me to drop the other shoe, so to speak, and reveal these mortgages as some sort of big scam, but if so, you will be disappointed. I have always thought that a long-term prudent investment strategy is, so to speak, to be overweighted on real estate. Over the past 50 years, the mortgage rate has averaged 1% to 2% more than the average annual appreciation in housing prices, but the homeowner gets the leverage from a 20% down payment plus ?inside buildup?, meaning you don?t have to pay income taxes on the gains as they are accumulating. That boosts the average annual gain from 6% to 12%. Even after paying 1% in property taxes and another 1% in insurance and repairs, the average annual gain on your equity is 10%, compared to an 8% mortgage rate (all these are long-term averages). Plus you get to live in the place.
I used to add some comment to the effect that another advantage is you couldn?t go to the bank and withdraw your equity buildup in the house easily, but that?s out the window these days with all the second mortgages and home equity loans. Which leads to the major problem of reverse mortgages ? many people have re-mortgaged their home so much that there isn?t much equity in spite of the rapid rise in prices. And if you don?t have much equity, the whole concept loses its value.
So reverse mortgages make sense only if you have no existing mortgage, or at worst a very small mortgage. Also, taking out a reverse mortgage at age 65 means you have immediately depleted your nest egg, and won?t have the increased equity to fall back on a decade or two from now. But increasingly, for people who are forced choose between losing their current home or not, reverse mortgages are quickly becoming the wave of the future. And as a result, the overall personal saving rate, which reportedly is already negative, will sink even further.