Monday, November 15, 2010

A Completely Different Perspective on Reverse Mortgages

A Completely Different Perspective on Reverse Mortgages
My discussion today is not about the ins and outs of a reverse mortgage, but rather a review of the rationale behind them. The federal government defines a reverse mortgage as “a product that allows you to convert part of the equity in your home into cash without having to sell your home…” Just about every time I watch TV, I see advertisements that pitch them as “the smartest thing you could do if you’re 62 or older.” But I see things differently: I completely disagree from a realistic, common-sense, and above all financial standpoint.

We have (so-called) experts encouraging Americans to make the largest down payments possible when they purchase their houses – so they can have smaller mortgages. Then, they are encouraged to do everything possible to pay off and eliminate those “interest-sucking” mortgages as quickly as possible!

And then, at age 62 or older, when these very same homeowners are financially broke (but living in homes they’ve paid off), they’re told the smartest thing they can do is to get a reverse mortgage, which literally means re-mortgaging those very same houses they worked so aggressively to pay off? If you think about it for just a moment, you’ll see that it’s rather backwards, and not at all smart. Really, how many financially wealthy individuals do you know who have reverse mortgages? The answer is NONE! And I’ll explain why in just a moment.

But before that, as I always echo, we need to avoid making financial decisions based on our emotions – yet again and again, it seems that the majority of folks allow themselves to be controlled by what I term extreme emotional nonsense.

It sounds pretty good – trendy, even – to hurry up, pay down your mortgage, and avoid those “money-sucking” interest payments. But in the end, will a reverse mortgage be interest-free? Of course, not! Those lenders have one goal: to make money. And guess how they make it – through the interest that is factored into each transaction.

So instead of making mortgage decisions based simply on the emotions surrounding costs, it behooves investors (and advisors, alike) to consider PROFIT. You see, in the world of savvy financial planning, there is one universal law, just like the law of gravity – because it works 100 percent of the time, whether you believe it or not, like it or not, or even know about it or not. And that law simply states that there is always an opportunity cost (otherwise known as the alternative forgone) for every dollar spent.

So instead of aggressively paying down/off your house, could you put those dollars somewhere else, where they could earn over and above the net cost of your mortgage? If the answer to that question is yes – and in most cases I have analyzed, that happens to be the case – you’d be making an unwise financial move if you used those valuable dollars otherwise. The interesting thing, though, is that if you really think about it, that’s why reverse mortgages are so popular these days – because some seniors have cash flow issues.

In the Baltimore-Washington DC corridor where I live (and I love it here), seniors lose their homes every year, in spite of the fact that they owe no mortgages. They learn the hard way that things like property taxes, which you owe for the life of your house, trump every mortgage loan. The thing is, what really matters at the end of the day for any homeowner (whether they agree about this fact or not) is a constant available stream of cash flow. So racing to eliminate your mortgage at the expense of a consistent cash flow becomes, quite frankly, pretty stupid – financially speaking.

For instance, given today’s mortgage rates of about 4.5 percent (and assuming that interest payments are tax deductible, given what we’ve been hearing on the news lately), we’re looking at a net cost of 3.4 percent (given a 25 percent marginal tax bracket). I know of several safe, secure, tax-advantaged savings programs that are paying 5 to 5.5 percent fixed interest. If you do the math, there’s a clear arbitrage PROFIT of about 2.1 percent – that would not be sacrificed by eliminating the mortgage payments.

You must also keep in mind that equity in a house is very volatile and risky because no one can control its movements, regardless of whether they might think or wish they can. So to bet your retirement on plans to get a reverse mortgage later might just reveal a nasty surprise – remember less equity in your home will mean little to no money flowing.

Please do not infer that I am opposed to reverse mortgages across the board, because I would recommend a reverse mortgage for someone who has been the victim of bad financial advice and is already left with no option but to REVERSE the very mortgage they just paid off. If you’re not there yet, however, you may want to think twice.
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3 comments:

  1. Wonderful article. Congratulations! I really like what you said. It makes sense to me. I always thought that behind the reverse mortgage there is a trap in which you "poor victim" will fall sooner or later.RAFAEL D. MARIMON

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  2. Mr. Marimon
    Thank you for reading and for your comments, as well.

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  3. You are so right. I hate to admit it but the marketing media keeps fooling the public and most advisors are not helping us with knowledge like you have here.

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