Q. I am receiving numerous sales calls for reverse mortgages from many sources. Please tell me about the downside to this program, if there is one. —W.W., Austin, TX
A. Historically, reverse mortgages have had two major drawbacks. First, they were relatively expensive in closing costs, insurance cost and interest rate. Second, most of the people who took them out shouldn’t have. Recent reforms have reduced the costs for reverse mortgages. New regulations have limited the amount of the loan value that a borrower could take out in the first year.
The problems with reverse mortgages came about because they were often given to people who had no other assets, were in debt, and really needed to rethink their shelter needs rather than borrow. The result was that borrowers would take out the maximum amount and then fail to make tax and insurance payments. This put the lenders in a tough place. That’s why the two major lenders, Bank of America and Wells Fargo, withdrew from the market.
But if you are retired, healthy and not dead broke, new research indicates that a reverse mortgage can be what they were hoped to be— another tool for managing retirement income and spending. The change began about two years ago, when Barry and Stephen Sacks published an article in the Journal of Financial Planning showing how a reverse mortgage line of credit could be used to increase the probability of not running out of money in retirement. Indeed, the use of a reverse mortgage line of credit could often increase the net estate of borrowers at death compared to more conventional paths. (See my column about it here.)
Since then, other financial planning researchers have confirmed these positive findings. Reverse mortgage lines of credit are slowly becoming a working tool for financial planning. One thing that contributes to the use of reverse mortgages is that the money borrowed is tax-free, since it is your home equity. Added withdrawals from retirement accounts, on the other hand, can be burdened with high tax rates.
Q. My wife and I (both 37) have saved up close to $100,000 for our emergency fund and other "short term" goals like replacement vehicles (current vehicles are 7 and 12 years old) and home repairs. While we don't need this money immediately, we are planning to use the car and home money sometime in the next five years. With that in mind, I know it isn't prudent to invest it in equities, but it pains me to watch it sit in the bank earning next to nothing. Is there something with reasonable risk like corporate or muni-bonds that I should look into putting the money in until it is needed? Where do I start looking? —G.P., Frisco, TX
A. To get any yield worth talking about, it is necessary to take some risk. So the real question for you is how much are you willing to risk in order to get some amount of yield today? Here, GNMA funds— the funds that invest in pools of government-guaranteed mortgages— are interesting because their yield has historically been higher than their effective maturity would lead you to expect. This isn’t a free lunch: If interest rates decline, home owners will refinance and you will miss the gains that investors in traditional bonds enjoy when yields decline.
Two well-known low-cost, no-load funds are good examples. The Fidelity GNMA fund (ticker: FGMNX) has a current yield of about 2.5 percent. That’s about the same as a 10-year Treasury, but the effective maturity of the fund is much shorter. You get a nice yield (for the current market), so what’s the risk? Well, in 2013 you lost 2.17 percent. To find another losing year, we have to go back to 1994—20 years ago— when the fund lost 2.00 percent.
Vanguard GNMA Admiral shares (ticker: VFIJX) is another example. This fund also yields about 2.5 percent and has a relatively short effective maturity. Like Fidelity GNMA, it suffered a loss last year, 2.13 percent. And you have to go back 20 years for the next loss, 1.43 percent in 1994.
Morningstar ranks both of these funds five stars and both have consistently ranked in the top 20 percent of GNMA funds or better. The risk here appears to be about a year of interest income.