Annuities ‘Safer’ Than Reverse Mortgages, Economist Claims

Claiming that high origination fees and complicated terms make reverse mortgages too risky for most older borrowers, a prominent economist suggested in a recent newspaper column that homeowners who need to tap into home equity use an annuity-based strategy instead.

The Department of Housing and Urban Development is hiding a better option than the reverse mortgage from consumers, Boston University economics professor and financial planner Laurence Kotlikoff wrote in a Monday column that appeared in the Seattle Times. The Home Equity Conversion Mortgage program, Kotlikoff claims, buries potential borrowers in fees and confusing terms that even a counseling session can’t sort out.

Kotlikoff starts with a basic overview of the HECM, calling the product an IOU from the borrowers — which he calls the Smiths — to their lender. In the columnist’s opinion, the only scenario in which the Smiths come out ahead is if they have no heirs and die at home.


“But if they die with heirs, or if they need to move to a nursing home or near their children, the Smiths’ share of the proceeds from their house’s sale becomes a big deal,” Kotlikoff writes. “This share can be quite small, for many reasons.”

He then lists high interest rates, the adjustable-rate feature of some HECMs, and the “five different fees, some huge” associated with originating the mortgage as reasons why the Smiths may not end up with a significant quantity of cash after the sale of the home.

“These potentially high rates and huge fees don’t cost the Smiths anything until their exit day,” he writes. “As a result, they may pay little attention to what is owed.”

Kotlikoff — who mounted an independent write-in campaign for president in 2016 with running mate Ed Leamer, another economics professor — then goes on to accuse HUD of providing insufficient information on its website, and claims that the mortgage counseling process won’t help untangle the fine-print knots.

“There, potential customers doubtless have their heads spun with talk of adjustable ‘Libor rates,’ ‘annual insurance premiums,’ plus the various fees,” Kotlikoff writes.

Instead, the professor recommends what he calls a “home-rolled” reverse mortgage, in which the borrower obtains a regular fixed forward mortgage, then spends the proceeds on fixed annuities that pay a higher rate than the mortgage loan. While he notes that this strategy also could potentially leave heirs in the lurch, he recommends giving “gifts to heirs through time,” and also suggests purchasing annuities from multiple insurers to spread out the risk of one or two issuers going out of business.

“No, they won’t get nearly as much immediate ‘free’ money. But they won’t get ripped off,” Kotlikoff concludes.

Read the full column at the Seattle Times.

Written by Alex Spanko

Join the Conversation (8)

see all

This is a professional community. Please use discretion when posting a comment.

  • It is odd when those with what is considered a strong economic background compare an asset to a debt. An annuity is owned by the consumer while a reverse mortgage is owned by a lender.

    Since among reverse mortgages only adjustable rate HECMs provide loan proceeds after closing but only does so by the election of the borrower while the annuitant receives cash as specified in the contract. The HECM can terminate due to the borrower moving or transferring title, through the death of the last surviving borrower, not paying taxes and insurance and other means. Death or full payout (annuity for a term certain) is the only way that an annuity will terminate.

    Each of the financial instruments have different purposes and different structures so comparisons can be made but is a rather futile exercise since the two fulfill different needs.

    • Your comments hold a lot of validity but I disagree with a couple of points.
      You are 100% correct that an annuity is an asset and a reverse mortgage is a liability, a fact many reverse mortgage professionals seem to ignore, but there are some very strong reasons to “compare” an annuity and the Tenure (lifetime) option of a reverse mortgage.
      Yes, the client must remain in their home, they must stay current on their taxes and insurance, but if they do their “lifetime” payment option on a reverse mortgage can NEVER run out. Unlike an annuity that can simply end when the funds are depleted.
      Then of course you still have the premise of why should a senior consider using their available liquidity to purchase an annuity in such a low rate environment when they can save their funds and use the equity in their home to create additional positive cash flow…
      This is a very timely and relevant topic that deserves a lot more attention then it is presently getting…

      • Michael,

        There are not just annuities that are for a time certain or can run out due to market conditions on some underlying asset.

        Most individual annuities are either single or joint life. They are not subject to where one lives or if taxes and insurance are timely made. These annuities generally have riders that buyers can add to the annuity such as guaranteed payments until the later of death or a sum certain.

        We need to be proponents of HECMs, not annuity specialists. It is hard to do that without being able to do examples and how can one competently do examples without knowing basic HECM math?

      • James,
        Those comments I made were in reference to reverse mortgages not annuities. That is why I feel, under proper circumstances, the reverse mortgage Tenure option can be superior to an annuity. We are on the same page here.

      • Michael,

        We are not on the same page. While I agree with the first quoted sentence below, I do not agree with the second, since both single and joint life immediate annuities (the most common) do continue for the LIFE of the annuitant:

        “Yes, the client must remain in their home, they must stay current on their taxes and insurance, but if they do their “lifetime” payment option on a reverse mortgage can NEVER run out. Unlike an annuity that can simply end when the funds are depleted.”

        Few US company sourced joint or single life immediate annuities in the last half century have ever ceased before the annuitant has died, even in some cases when the insurer was no longer in existence.

  • Titles are so impressive but mean so little when it comes to analyzing HECMs. Just read what the author stated about HECMs and their balance due: ” If the Smiths are 62, have a $300,000 house and borrow $100,000 at a 6 percent rate on their HECM, they will owe $320,000 20 years later. If they have to move, they’ll get nothing from the sale of their home.”

    Here the author writes for the Seattle Times, an area of the country where home appreciation rates since World War II have generally been handsome. Yet he states that the home will only have growth of less than $20,000 in 20 years. But if the home increased by a mere 3% per year in that 20 year period, the value of the home would be $541,833, a much different value than his less than $320,000 at the end of 20 years.

    The economist further states that the balance due on $100,000 at 6% interest on a HECM will only be $320,000. It is clear he knows little or nothing about HECMs. At the end of 20 years, the balance due will be $424,456 if the effective average interest rate is 6%. Why is this economist so wrong? Because he did not bother to include the 1.25% annual rate for HECM ongoing MIP which will be charged monthly for 240 months. At the end of the loan, the balance due is not $100,000 in principal and $220,000 in accrued interest as the economist implies but rather $100,000 in principal, $268,515 in accrued interest and $55,941 in accrued ongoing MIP.

    So I get that the homeowner at loan termination will walk away with about $85,000 in cash if selling costs are around $32,400. Please remember that $85,000 is at the lower end of what the cash payout may be since a somewhat conservative appreciation rate of just 3% was used. So the amount of cash payout could be even
    larger. If the average appreciation rate in 20 years was just 5%, the homeowner would walk away with over $300,000 and perhaps facing some income taxes payable.

    Income taxes may result but assume that the Internal Revenue Code Section 121 exclusion applies and $300,000 was the purchase price of the home and should be none on the home based on the assumed sales price of the home at about $542,000 (appreciation rate of about 3%) and other assumptions. THEN there are the potential interest and MIP deductions, especially if the HECM transaction was a H4P.

    So how can any economist (or any other financial professional) compare HECMs to anything, if they do not understand how HECMs work? Even worse, if they do not understand how home appreciation works over a 20 year period, how can they determine what the outcome will be?

    Let us not get so carried away with annuities or become financial advisors before we REALLY know how HECMs work ourselves? Let us go out there and teach people like this economist how HECMs ACTUALLY work. Get familiar with how HECM math works. None of it is college stuff; I was a upper division math major at UCLA before switching majors.

  • Sadly, Mr. Kotlikoff’s ridiculous statements were picked up by other newspapers, including the Austin American-Statesman. I’ve never met an economist that would assume ZERO home appreciation would occur over a 20-year period. I’m also surprised that a so-called “prominent” one would make conclusions without understanding all of the details of the transaction.

string(100) ""

Share your opinion