In the vast universe of consumer borrowing, reverse mortgages get little respect. They cause the same kind of eyebrow lift as pawn tickets, car title loans, rent-to-own TV sets and leased car tires. When I write about them, the next day’s mail has chiding notes suggesting that I failed to tell the gruesome downside of reverse mortgages.
I plead guilty. So let me make a promise: in 2016 there will be a column about the downside of reverse mortgages.
But that’s next year. Right now I’d like to tell you about some new research that will be of interest to the millions of Americans who aren’t planning trusts for their great grandchildren.
Wade D. Pfau, a prolific researcher and professor of retirement income at the American College of Financial Services, recently completed a study that examined the probable results of seven different ways of using a reverse mortgage. Included in those seven ways was the option of not taking a reverse mortgage at all.
To do the research, he used Monte Carlo simulations, a method for determining the likely ranges of results. This method indicates the odds of financial survival for a household with a starting investment portfolio worth $1 million. (Hey, it’s a nice round number.) He assumed the retirees needed a starting income based on an after-tax 4 percent spending rate. In following years, he assumed an inflation-adjusted spending rate. He also assumed a $500,000 home, eligible for a reverse mortgage and a 62 year-old single borrower. (Borrowing limits are increased for age, reduced for joint ownership.)
Among the options he studied: use home equity first, use home equity last and use a monthly tenure payment. He also used three more complicated payment mechanisms. Finally, he also explored the legacy value of each way of using a reverse mortgage, i.e. how much money was likely to be left for heirs.
Here are what I believe are his most important findings:
- The lowest overall success rate, by far, was the “ignore home equity” route—no reverse mortgage at all. It had only a 40 percent 30-year survival rate. The others ranged from just under 70 to 90 percent. This strongly suggests that a reverse mortgage should be a tool middle and upper middle-income families consider.
- The overall best route was the monthly home tenure payment. This is a reverse mortgage that is based on your life expectancy. It makes a constant payment based on the owner’s age and the value of the home. It showed a probability of success over 80 percent. It also generally showed the highest median real legacy value. It was a big winner for periods over 30 years.
The monthly payment path also scored well in the best and worst Monte Carlo simulations. The path scored second among methods in the top 10 percent of outcomes and second in the bottom 10 percent of outcomes. While other methods of using the credit line were as good in shorter time periods, I’d give the nod to regular monthly payments because it is the easiest method to follow. Just cash your monthly check.
Yes, the cost of getting a reverse mortgage is higher than the cost of getting a conventional mortgage. But it’s lower than the cost of guaranteed minimum benefit products offered by insurance companies and you can be certain that every dime of reverse mortgage income will be tax-free. The income from financial products may be partially, or entirely, taxable, depending on its original source.
In spite of this and other positive research— and notwithstanding the fact that most Americans have most of their net worth in their homes— it isn’t likely that we’ll see a stampede for reverse mortgages.
Simple. We’re pretty irrational when it comes to decisions about our homes. We stay in houses that are larger (and more expensive) than we need. We hold being mortgage-free as a high ideal, regardless of our circumstances. And we have a strange desire to pass on “the family home” even if we have 5 children who don’t get along and live in different parts of the country.
To be sure, reverse mortgages aren’t for everyone. They shouldn’t be used to support errant children. They shouldn’t be used to stave off creditors for a few more months. They shouldn’t be used as a substitute for doing a clear-headed examination of your retirement circumstances.
On the other hand, if you are one of the many people who live in a home that has risen in value faster than your income ever did while you were working and you want to stay in it, well, an RM could be right up there with sliced bread.