Financial Planner for Retirement
Suzanne Wolfson, CFP® is the founder of For Retired Only™, a fee-based financial planning...read more
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- Paying for Senior Care with the Inheritance
- Lessons I Learned after My Father’s Death
- Thinking of Selling Your House? Read this First!
- How Much Can You Save with Advance Planning?
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- What’s in Your Parent’s Wallet? (And What That Means for You)
- Financial Planning for the Elderly: Assisting Clients & Their Caregivers
- Financial Planning for the Elderly: a Personal Perspective
Financial Planning for Retirement
The Real Cost of Reverse Mortgages
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Chances are, you’ve heard of reverse mortgages. But do you really know how they work? There are many professionals on both sides of the fence. One side will try to sell you on the upsides of reverse mortgages, and the other will warn you of the downsides. Let me tell you this, objectively: reverse mortgages can be a good solution for a certain type of consumer, but they are complicated. Understand how they work before you decide on this option.
Understand the Cost of the Benefits
As we have all learned over time, sometimes things that seem too good to be true are just that. Obtaining a reverse mortgage is an important financial decision; they are very expensive products and should be used only when they’re appropriate for the situation. It’s essential that you understand the actual price and implications, not just the upfront ones. Reverse mortgages can be beneficial and worth the costs, but consider the disadvantages before making your decision. Remember: a mortgage salesperson is not a financial planner and does not have a fiduciary responsibility to your best interests. Get objective advice beyond the required counseling meeting!
You’ve probably heard plenty about the benefits of reverse mortgages. They can:
- Stop your monthly mortgage payments
- Offer access to some of your equity without monthly payments
- Provide flexibility in your use of the funds:
- Credit line for emergencies
- Additional monthly stream of income
- Lump sum distributions
- Or a combination of any of the above
- Give access to tax-free money (as is the case in all equity loans)
- Qualify you easily (qualification is based on the property, not income)
- Allow you to stay in your home
- Offer independence and freedom of choice
Exercise Caution
Of course, all of these benefits sound great! But is a reverse mortgage the panacea? Is it the best solution to meeting life objectives if you have limited funds (equity-rich, cash-poor) and increased income needs? Yes, these types of loans can do all this, but make sure you thoroughly understand the high cost and terms, compared to other financial alternatives, before proceeding. Remember: if it sounds too good to be true…
I want to clarify here: I do think that reverse mortgages can be a great product, especially for older seniors who need to facilitate costly care needs such as aging in place endeavors or meeting the future needs of a healthy spouse when the other person’s health costs become significant. In fact, reverse mortgages are a part of my tool chest as a financial planner for the elderly. Sometimes it is the best alternative. I am thrilled that the product is evolving quickly and getting significantly better with time. I don’t deny that equity-rich, cash-poor retirees might want to consider leveraging their equity to enhance their lives, but as hassle-free as the reverse mortgage industry tries to make it sound, the cost and financial implications on the future unfortunately get downplayed in light of the benefits—especially for retirees younger than seventy-five. Age is a significant factor in this equation.
What are the Total Annual Loan Costs?
Compare annual percentage rates (APR), not interest rates. To understand how a reverse mortgage really works, think about your current circumstances and how they might change in the future. Consider these factors:
- Even though you’re not writing a check for closing costs, monthly payments, monthly service fees and mortgage insurance, it doesn’t mean you’re not paying for it! Those costs are merely added to the loan balance. You pay compounded interest on all of it, quickly accelerating the loan balance due in the future!
- You may have to pay off a valuable lower rate existing mortgage. Note the reverse mortgage rate is variable and can rise. You will also pay for mortgage insurance and additional service fees. What is the real cost of the money?
- There are other products that are significantly cheaper than reverse mortgages, and possibly other deferred loans that can help you finance home improvements. Deferral on tax payments can also help reduce your present expenses.
- If you reduce your equity quickly, as this product does, what happens if you need those funds in the future to finance expensive elder care? Your reverse mortgage agent may tell you that you can always refinance the reverse mortgage at that time, but front-end fees are very high—usually about 4–8% of the entire loan.
- One of the benefits of reverse mortgages is that you don’t have to repay the loan as long as you live in the home. But if your health care needs change—for example, you have a stroke or develop Alzheimer’s—and must go to a nursing home, you could lose that benefit. If you are out of the house for more than one year, you must then repay the loan.
- You lose your tax interest deduction until the year it is paid off.
- The loan balance grows quickly due to the compounding. Will your heirs be shocked and disappointed when they find out the loan balance that has built up? Perhaps you should discuss reverse mortgages with them before entering into an agreement. They might be able to facilitate other options.
- Is this the best tool to gain liquidity to purchase other things, such as long-term care insurance, annuities and additional real estate?
- Does the property qualify (based on the value and present condition of the home) without your needing to make large repairs?
- Does the net amount you get warrant the front-end fees?
Unfortunately, the pushers of this product often prey on the poor, seizing their home equity in exchange for a pricey promise or dream. The reverse mortgage can impact the aging home owner’s future ability to qualify for other benefits like supplemental social security, Medicaid, and other low-income government loans and services. As a buyer or borrower, be aware before entering into this type of financial arrangement. Frequently the benefits are presented in such a way that they blur the borrower’s understanding of the significant costs and the ramifications. Everything has a cost. Just know your choices and the total price before committing.
Posted in Financial Planning for Retirement: Suzanne Wolfson, Paying for Long Term Care, Reverse Mortgages, Weighing your Housing Options, What About My House?
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What are the other alternatives for the seniors that are cheaper? Too many times pundits, bloggers, and other financial experts like to say that a reverse mortgage is expensive but lack the proof of other cheaper alternatives. This transaction is expensive compared to what? Please provide other solutions. Many seniors are on a fixed income and cannot qualify for any other types of loans or mortgages. Selling the house is an alternative. What are the cost breakdowns of thi stransaction? Start off with 6% to 7% realtor fees on the sale of the home then the costs of moving which can run upto $6,000 or more depending where you are moving to. Add the down payment on a new house(5 to 20 % plus which then takes away a seniors liquidty) and the closing costs ( which can run another 2 to 3 % or more depending on the sales price of the new home. So, a revers emortgage sounds pretty good when you start comparing the other alternative. So, what other alternatives are out there that are not expensive?
Suzanne,
I think your article has merit with the points that you raise. However, although you suggest there is a place for reverse mortgages, you also in my opinion, lose creditability when you suggest “the pushers of this product often prey on the poor, seizing their home equity in exchange for a pricey promise or dream:. If financial planners and CPA’s would work together with a mortgage advisor, maybe we would have better success for the seniors.
Victor;
This is an important question. The first thing I always ask in this type of situation is what is the reason/need for accessing the equity? Is it for necessary home improvements?—elder care? What kind of expenses need to be covered? Can your needs be met through any other government or agency deferred loans? (such as those available for home improvement or with property-tax deferral?) Does the lower fixed income allow for other benefits now or in the future? Do you want to pay off your low interest loan for additional funds at a much high cost—as it is not deductible until pay-off time?
To fairly evaluate alternatives I would need to consider the person’s total financial and personal parameters. Like all financial decisions, they can’t be looked at in a vacuum. Everyone has different parameter and the options change with the markets. As I said in my article, Reverse Mortgages have a place and that is why they are amongst my tools when appropriate, but consumers should definitely look at the Annual Percentage Rate (APR) after tax for comparison and consider the expense of compounding interest on all the build up…. equity can spiral away.
You see the sale of the property as the only other alternative and, yes, that has costs of about 5-6% in commission and a bit more…. but a Reverse Mortgage can also cost 4-6% in loan costs just to initiate and then how much are you paying with compounded non-deductible interest?—with the mortgage insurance, on-going processing fees, and the payments you are not making? If you or your wife will never (Remember to stay realistic.) have a future financial need for the remaining equity as these loan balances grow fast nor have any legacy issues, then none of the costs matter. Ask yourself the “what if’s”, such as if later being you may be forced to sell the house because, for example, it becomes unsafe for you/your spouse or one/both of you needs help or medical care. I want you to consider the possible elder care costs, which are potentially huge, that everyone thinks will never happen to them. Selling the family home or moving someplace else due to care needs can be the hardest thing we do in our life as the house often holds comfort, memories, and a sense of security. Is quickly eating through your equity the trade-off you are willing to make for the benefit desired? Then it is okay as you are TRULY aware of cost!
Keep in mind that the available funds from such a loan can be significantly limited if you are under 75-80. Because of the credit crisis the criteria for equity lines, which in the past were significantly cheaper and could be structure as a reverse without the high costs, are now getting difficult to get or keep. This makes obtaining a Reverse Mortgage a more viable option depending on the person’s AGE and needs if a large amount of funds is needed. I absolutely do believe that people have the right to benefit from their equity before it is too late.
Depending on the location, value of the property there is another new product (Equity Key and REX) available which SOMETIMES works if you are willing to give up 50% of future potential equity growth. These products also sound too good to be true, but also sometimes is the right fit.
There is also private financing available, if you know how to find the right resources, that would be willing to lend on a low-risk loan such as these are allowing you to create your own reverse at a lower cost. These can be a win-win for both the direct investor and the borrower.
Every financial choice and decision is different depending on the situation and all people involved. The important thing is that people understand the total cost and risks—not just the variable interest rate quoted, front-end fees, and benefits sold. People need to think how this can effects them 7, 10, and 15 years out?
During my 24 years as a Financial Planner I have seen many people be enticed by product benefits only to later on be shocked by what the true cost was and shocked by what they had agreed to. Often they will say they were not told. So you must be aware and know what you are really getting. A Financial Planner’s job is to do the due diligence and assist clients in making important decisions that will meet the broader spectrum of needs, considering their parameters and objectives. We (Certified Financial Planners, CPAs and Registered Investment Adviser) have a legal responsibility to our client’s best interest based on our knowledge, experience and technical evaluating tools. Our interest should not be about getting a commission for the company due to a sale.
Suzanne Wolfson
FOR RETIRED ONLY
If you have any further questions about your situation, please feel free to call me.
Suzanne
So what ARE other alternatives? Living on small pension+social security, at age 73. Taxes $10,000 year, and $700 payment on $85,000 equity loan. Are there gov’t programs for homeowners who’re not considered “destitute?” Very tempted to get say, $800 month income, are no longer make equity line payments. But I’m too old to do stupid things. Daughter concerned this isn’t right. Sons would prefer I sell and downsize but NJ homes too costly. House value is $416,000.
Pls don’t share my e-mail address. Thanks.
Monica,
Many sons and daughters are not familiar with Reverse Mortgages. One of the first thing that pops into their thought process is that the bank can take your home and they own it. This is just liek any other mortgage. If your children have a home and have amortgage on it does it mean that the bank owns therir home and can the bank take it away. The only way a bank can take your home is through a foreclosure and several things need to happen: If you do not maintain homeowners insurance on your home, If you do not pay your property taxes, and finally if you do not maintain your homee in good living conditions, these are the times that the bank can take your home on a reverse mortgage. Basically these are the same reasons that a bank can take your home on a normal forward mortgage. In addition, the banks can take a home away if payments are not made on aforward mortgage. I think your daughter needs to talk to a professional in the reverse mortgage industry to find out the facts. Decisons based on facts are good decisions. However, it is your home and you paid doen the mortgage. You have every right to do what you want and you are right it would be difficult to find a home in NJ that can fit your budget. I am sure it would be nice for you to have some cash reserves and no mortgage payment. Hope things work out for you. Have a great positive day!
Monica,
You need to talk to a Financial Planner who understands Reverse Mortgages and elder issues. I am a bit confused by some of the information you provided, but it seems you are struggling to make your monthly payment. And, yes, you can take out a Reverse Mortgage to help you with your payments or to downsize in order to reduce expenses. However as I do not know the details of your specific circumstances it is hard to tell her which direction to go. Remember, whatever decision you make needs to take into account possible future financial needs, such as additional costs which, for long-term care, can be quite high.
This exact issue is one of my concerns for people in your age range–I worry that too many people can end up spending all their resources, including their equity, which gets quickly eating up by a Reverse Mortgage as the loan balance grow with the compounding of costs. Then later on when they need funds for care, their choices can be very, very limited.
I would also suggest you call your local department on aging and inquire if they have any deferred property tax loan programs which could help your cash flow. You would only have to repay it after one’s death or if the property is sold. That’s a local option. Some cities and counties also offer low interest rate loans for necessary repair, which are also on a deferred basis.