Wanted: Homeowner, age 62 or older. Close to paying off your mortgage. Living in the home you own. Looking for an income stream. Equity is a must.
If this sounds like you, you may be squarely in the sights of a financial services professional trying to convert your home into retirement cash flow.
As more baby boomers reach retirement age, the marketing drumbeat of products and services geared toward this generation will only intensify. The financial services industry is quick to recognize and tap any new potential source of revenues, especially with reverse mortgages. And while there are some great uses for reverse mortgages, there is even greater potential for abuse.
Home Equity Conversion Mortgages (HECMs), also known as reverse mortgages, have been around since the 1960s. But in the last decade, they have increased in popularity tremendously. A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash. There are several qualifications you must meet. The youngest named owner on the deed must be at least age 62; you must either own the home outright or have a small enough mortgage that it can be paid off with the proceeds from the loan; you must live in the home; and you must have a consultation with a HECM counselor prior to closing.
There are several variables that determine how much you can borrow. Generally, the older you are, the lower current interest rates are, and the greater the value of the house, the more you can borrow. If there is more than one borrower, the age of the youngest borrower is the one used for the calculation. Additionally, there are several ways to receive the proceeds: Lump sum received at closing; tenure-equal monthly payments for as long as you live in the home; term-equal monthly income for a fixed number of years; a line of credit that can be drawn on as needed until exhausted; or some combination of the above.
We believe that, although the sales pitch for a reverse mortgage may make it sound like a “no-brainer,” you should only consider this as a source of last resort to supplement your income to meet critical expenses. Let’s say that again: It should only be a last resort for critical expenses.
Think about this: With a traditional loan, you make payments of principal and interest to the lender until the loan is paid off. With a reverse mortgage, every dollar you receive will eventually have to be paid back with interest, to the bank. While you’re using that money without payments being made, interest is still compounding each year. Ultimately, this is paid back to the lender and becomes his profit. This stealth compounding of interest, in conjunction with up-front costs that are typically rolled into the loan, makes this a very expensive way to access your equity. You will never owe more than the house is worth, but the effect of the compounding of the interest can eat up all of your remaining equity, leaving nothing for your heirs.
If you have decided that a reverse mortgage is necessary for you, be sure to shop it around. The costs can vary widely from one lender to another. Make sure to get it all in writing before making your decision. Also be sure that the mandatory counseling is coming from someone who receives no funding from the lender or the mortgage industry. It’s also a good idea to get a second opinion on whether a second mortgage makes sense for you from a trusted advisor who is not associated with the group pushing the mortgage.
AARP (which does not endorse any reverse mortgage lenders or product) has a well-written 50-page brochure titled “Reverse Mortgage Loans – Borrowing Against Your Home,” which clearly describes the pros and cons. On the very first page, they make the following important point: “Investing the money from these loans is an especially bad idea because the loan is highly likely to cost more than you could safely earn. If anyone is trying to sell you something and recommending you use a reverse mortgage to pay for it, that’s generally a good sign that you don’t need it and shouldn’t be buying it.”
We couldn’t agree more. We believe that the practice of attempting to tap a homeowner’s equity to generate commissions from the sale of any type of product should be illegal. The securities industry already prohibits registered securities representatives from engaging in this practice. We call on the insurance industry to follow suit. Your home equity is a treasure you have carefully accumulated. It shouldn’t be viewed as “happy hunting grounds” for anyone with a pen in their hand.
Nathan Bachrach and Ed Finke of the Financial Network Group offer portfolio management services at their Sycamore Township office. Submit your questions to simplymoney@fngltd.com . And tune in to Simply Money daily on WKRC (550 AM) from 6 p.m. to 7 p.m., and on the WXIX (Channel 19) morning and evening news.
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