NerdWallet: Reverse Mortgages Can Be ‘Relief Valve’ for Bear Markets

Reverse mortgages aren’t cheap for seniors and should be avoided particularly for short-term needs, but recent research has identified an effective use of the product concept for those who have investments during volatile periods of market activity. This is according to Liz Weston, a certified financial planner and finance expert at NerdWallet.

“Stay-at-home orders may have taken away jobs needed to make ends meet, while low interest rates and a volatile stock market have endangered income from retirement savings,” Weston writes. “A reverse mortgage could be exactly the right tool at the right time. Or it could be an expensive mistake. It’s important to understand exactly how these loans work and to explore alternatives before you commit.”

While most of the upfront costs are taken out of a loan’s proceeds as opposed to coming out of a senior’s pocket, but the requirement of a 2% upfront mortgage insurance payment, plus an additional 0.5% annual charge along with origination costs and lenders’ fees make reverse mortgages an expensive way to borrow, Weston contends.

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“Many borrowers don’t realize this, or that the debt can grow to the point where they may not have anything left to borrow against in an emergency or to leave to their kids,” Weston says, attributing that assertion to Barbara Jones, senior attorney for the AARP Foundation.

Low income seniors should also look into other options for financial relief, with many not realizing that they likely qualify for the earned income tax credit and forbearance options on their existing mortgage. However, that doesn’t mean that reverse mortgages are valueless in her eyes, she says.

“Although financial planners long considered reverse mortgages to be a last resort for struggling seniors, researchers in recent years found a potential use for more affluent people: as a relief valve to take the pressure off investments in bad markets,” Weston writes. “Tapping a reverse line of credit for income instead of selling beaten-down stocks gives investment portfolios a chance to recover along with the market.”

This, she says, is based on research conducted by Wade Pfau, professor of retirement income at the American College of Financial Services.

“A reverse mortgage also can provide monthly guaranteed income that isn’t dependent on stock market swings or a healthy labor market,” Weston writes, citing VP of retirement strategies at Finance of America Reverse (FAR) Stephen Resch in describing this potential use. However, an income annuity can often be used for similar purposes, she says.

Read the article at NerdWallet, and listen to episode 11 of The RMD Podcast where we spoke with Dr. Pfau about using a reverse mortgage as a buffer asset in a volatile market.

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  • The comment below is copied from the comment I posted on the NerdWallet website. So a phrase like “from above” refers only to the NerdWallet article. All references to “the author” are directed to the author of the Nerdwallet article, not Chris Clow.

    From above, “you can, however, wind up in foreclosure if you fall behind on property taxes, homeowners insurance or homeowners association fees.” If the home has no mortgage or any mortgage, the same problem of potential foreclosure (other than homeowner’s insurance) exists but anyone who would go without such insurance has a risk tolerance higher than most homeowners.

    The author states: “HECM loans require a 2% upfront mortgage insurance payment, plus an additional 0.5% annual charge, on top of origination costs and lenders’ fees.” Yet the author fails to tell us what the 2% and 0.5% are being multiplied by. The 2% upfront mortgage insurance premium (MIP) is multiplied times the lesser of 1) the appraised value of the home or 2) the FHA lending limit which is currently $765,600. The upfront MIP is then generally added to the unpaid principal balance (UPB). The upfront MIP is accrued just one time, The ongoing MIP is accrued monthly at an annual rate of 0.5%. The accrued amount is calculated by dividing the 0.5% rate by 12 and then multiplying the result by the HECM UPB. The resulting product is then added to the UPB.

    The author claims the MIP and closing costs of a HECM are not cheap; however, if HECM proceeds are used to prevent losses from converting the portfolio into cash during an substantial downturn in the stock or bond markets, then the upfront costs of the HECM may more than offset the upfront costs of the HECM. It is unclear why the author did not point that out.

    “‘They don’t quite understand what compounding interest means,’ Jones says. ‘So they don’t have the equity in their home that they thought they did.’” The home equity computation is straight forward. It is simply the market value of the home minus all debt against the home.

    Reverse mortgages provide monthly statements showing the current unpaid principal balance on the loan. So it should be no problem knowing what the debt against the home is from the reverse mortgage. Now as to other debts against the home, that information is NOT contained on the reverse mortgage monthly statement since the reverse mortgage lender is generally not the lender on other debts (if any) against the home. Now we come to a very real problem for borrowers which is what is the value of the home from month to month. Reverse mortgage lenders are not independent appraisers and lack the information to provide the value of the home. So why the reverse mortgage is a problem in computing home equity is not apparent from the article or in real life.

    The author claims: “A reverse mortgage also can provide monthly guaranteed income.” Let us be clear. The loan proceeds from a reverse mortgage are NOT income. Income does not have to repaid; however, when the reverse mortgage becomes due and payable, the unpaid principal balance on a reverse mortgage must be repaid based in accordance with the nonrecourse provisions in the loan documents.

    Comparing an income annuity (i.e., most likely an immediate annuity) to the adjustable rate HECM’s tenure payout option is not as simple as presented. If the annuitant passes away, normally all payments from annuity cease unless there is a rider stating otherwise, none of the premium payments to acquire the annuity are refundable. On a HECM in more recent years, all one owes is what that borrower has received in total payouts plus accrued interest and accrued MIP minus all mortgage payments that the borrower may have made to the lender. So, for example, an annuity costs $70,000 and pays the annuitant $400 per month for life. If the annuitant lives for 5 years, the annuitant will only have received, $24,000 which means the estate lost $46,000. Let us say that an adjustable rate HECM with upfront costs of $18,000 was paying the borrower $400 per month and the effective interest rate during those five years was 4%, then the amount due on the tenure payouts plus accrued MIP and interest would be $49,391 meaning the estate is out $25,391 since the borrower received $24,000 during the five year period before death.

    With an annuity, distributions continue no matter where the principal residence of the annuitant is located. This asset attribute is known as portability. With a HECM, tenure payouts will end if any of the loan covenants are broken — one of which is that at least one of the borrowers must live in the home as their principal residence. The definition of a principal residence for purposes of the covenant is living in the collateral more than half of the days in a calendar year.

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