"We were comfortably well off, and we wanted to release some of the funds we had tied up in our home." – Mrs. Carolann Prast explaining why she and her husband took out a reverse mortgage on their home. – The Wall Street Journal 11/13/2007
I have become somewhat of an expert on reverse mortgages, not by any deep knowledge I have of the products but because so few people understand them at all. I recently told the Los Angeles Times:
"In the future we’ll see new vehicles, new pricing, new ways of pulling out just the amount of money that you need. I fully expect a reverse mortgage to be as normal as a 30-year fixed."
There is a time and place for just about every imaginable financial product. But in the case of Mrs. Prast and countless other victims of their own appetites, there are many places reverse mortgages shouldn’t be used.
Mr. and Mrs. Prast “freed up…an extra $21,000 a year formerly used to make mortgage payments for travel and indulgences like paying for a granddaughter’s semester in Australia.” I wish I had a day off for every time someone told me they wanted to “free up” some of the equity in their home, or “put some of that money to work for me”.
You do not “free up” money by borrowing it. You encumber assets to borrow cash. Financial freedom comes from having no debt or obligation, no claim on your assets or earning power. You cannot borrow your way to financial freedom.
You do not “put your equity to work for you” by borrowing money from the bank. Your equity is already invested in an asset; it is “working” in your property. You do not make your property “work harder for you” by borrowing the bank’s money to invest it elsewhere. Your property is still just your property. Your likely uncertain investment will be weighed against the likely certain cost of the debt.
Consider this, when you borrow money from the bank to invest it you are betting against them. They could put their money in the same investment you are making, but they chose instead to lend it to you and get their interest payments. Not that you can’t win that bet, but understand that you are betting against the bank and they are not usually fools.
For most people, borrowing out the value of their home to buy luxuries like travel and to spoil their granddaughter is really a questionable tradeoff against guaranteed interest expenses that retirees have no earned income to pay off. One client recently called us for advice on a loan offer they received that had $16,000 in upfront fees alone! Sure, you can’t be kicked out of your home and the total debt allowed is capped. But if that is all the security you seek in your Golden Years, to die broke in the bank’s house, you are aiming too low.
Don’t blame the banks. There are situations that work perfectly for these products and they are an increasingly flexible and useful tool in the hands of responsible consumers. As competition increases costs will come down. But we live in a time of flagrant financial irresponsibility and greedy people who have been bailed out by low interest rates, high economic growth and historically record low unemployment. Despite what the media says, it doesn’t get any better than this. If any of these three should stumble, there will unfortunately be many who are insolvent. If all three tumble, things could get ugly. Fortunately, you are our client and you are forewarned.
Copyright © 2007 MWBoone and Associates, LLC All Rights Reserved. MWBoone and Associates is a Registered Investment Advisor. Further disclosures at www.mwboone.com. Securities offered through Linsco/Private Ledger Member FINRA/SIPC.