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Reverse Mortgages: Good Or Bad

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : 06-Feb-2007

Dear Subscriber:

Today clients are hearing more and more about Reverse Mortgages (RMs), and the question seems to be are they a good or bad tool in a financial/estate plan. Like most things in life, the answer depends.

What is a RM?

A RM is a special kind of loan that can be obtained if you are at least 62 years of age (if married, the youngest must be at least 62) and own your own home/condo (planned unit development) or co-op (mainly in New York). A RM converts a portion of the value (equity) of a home into instant cash. One other key feature to a RM is that there are no income, asset, or credit requirements to obtain the loan.

The amount of money that can be created from a RM depends upon on the following factors:

1. The age of the youngest borrower;
2. The value of the home (up to a certain limit for some programs).
3. The interest rate (for some programs).

The pool of money that is created from a RM can be received in a lump sum, partial lump sum, monthly payment, line of credit or any combination.

A RM is a non-recourse loan. There is no personal liability to the borrower, their estate, or to their heirs (the house is the only collateral). Also, the borrower is not required to make monthly mortgage payments. Interest and servicing fees accrue over time.

Why do clients gravitate to RMs?

Unfortunately, many times the answer is because an older client is pitched a RM by an advisor who doesn’t understand them or does and doesn’t care if it is the proper tool for the client. You may have seen James Garner (Maverick from TV and the movies) pitching them on TV and because he says they are wonderful, elderly clients inquire further.

It is true that many clients have financial problems when reaching retirement. Their pension plans did not perform as well as they had hoped and living expenses (especially medical) have gone up substantially. For many clients, their biggest asset is their home, but that is not a liquid asset that helps pay bills.

The client is told they can obtain a cash payment for life (assuming they live in the home under the RM guidelines) or a lump sum of cash if they enter into a RM and they do not have to make any payments on the loan.

It’s like “free” money, right? Wrong. There is interest charged on the loan at not so insignificant lending rates, and because the client is not making monthly payments on the loan, the interest that is accruing is compounding on itself, which will accelerate the amount of equity being removed from the house.

Why do Advisors like RMs?

The majority of advisors that I spoke with sell them because they make very good money on RMs, and because the sale to an elderly client who needs money is not too difficult. Think about this, if postured correctly, an advisor could make in excess of $6,000 on a RM where the home value is only $400,000.

Why should you (or one of your parents) purchase a RM?

Because in some circumstances they are appropriate.

When is a RM appropriate to purchase? In one of three situations:

1) If the client needs money to pay bills (and has no other assets), and if the client is removed from the house it will have such a profound negative affect on the client that their mental and possible physical health will decline.

This is the classic client. The client has no money, can’t pay bills and the only major asset is the house (with no or little debt). While it would make much more sense to sell the typically larger house to raise needed cash, the client and the rest of the family believe that if the client leaves the abode, the mental affect of leaving the home will negatively affect the physical health of the client. In other words, if you move elderly clients from the homes they have lived in for 30+ years, where all of their memories are contained, and move them to a new condominium or retirement home, they might become so depressed they will die shortly thereafter.

2) The client wants, but does not need the money, and will not have mental or physical problems if he/she leaves the house (and does not care about leaving the maximum amount of wealth to the heirs).

This is also a classic client who says “I came into the world with nothing, and I am leaving with nothing.” The client understands that a RM is going to be the ultimate negative amortization loan where the interest compounds on it thereby lessening the value of the asset passed to the heirs. The client understands and does not care.

3) The client has a large estate-tax problem and wants to maximize the inheritance passed to the heirs.

Think about it. If the client’s home stays in the estate, there will be a 50% estate tax levied on the value of the home. The home will be sold, and what is left will pass to the heirs. A better way to lessen the size of the “taxable” estate would be to take out a RM, receive an income stream from the RM, and gift that money to an Irrevocable Life Insurance Trust (ILIT) where a large life insurance policy can be purchased which will pass “estate-tax” free to the heirs. When you run the numbers, you will find this works quite well.

Summary

People who read my newsletter on RMs usually get the feeling “I don’t like them.” However, they can be a valuable tool for the “right” client. My opinion is that many times they are not sold to the right client, which is one of the reasons I try to give a different perspective on the topic.

If you or a loved one have no money, but you have a house with no or little debt, and if leaving the house will negatively affect the well being of the person in need, then a RM is a viable tool and should be strongly considered. If the client has a significant estate tax problem, a RM should be strongly considered.

If a client just wants “free” money to spend, I do not suggest using a RM.

Because of the nature of these brief newsletters, I cannot go into the needed detail to fully explain the topic. If you would like a case study so you can understand better how RMs work, please e-mail info@trustmakers.com.

Roccy M. DeFrancesco, JD, CWPP™, CAPP™

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ABOUT THIS EDITOR:

Roccy DeFrancesco, JD, CWPP, CAPP, MMB - Author and lecturer, Roccy specializes in advanced estate and asset protection planning. Roccy's passion is to teach advisors how to implement lawful strategies that will hold up for the test of time.

Full Bio - Email Roccy