You’ve heard it before: If something seems too good to be true, it likely is.
Yesterday in his popular State of the Market YouTube series, Chief Income Strategist Marc Lichtenfeld tackled one of the financial world’s most insidious products – which is also one of its most tempting ones.
Especially when they’re peddled by stars like Tom Selleck…
I’m talking about reverse mortgages. Reverse mortgages offer borrowers a dazzling amount of money upfront or in installments, and they have to be paid back only after the borrower moves out of the house or passes away.
It sounds like the perfect solution for aging in place. Most borrowers would love this kind of arrangement…
If not for the fact that as the years went by, most borrowers would be going broke.
The devilish genius of reverse mortgages is that they use the power of compounding against the borrower. Between mortgage insurance (which is required for everyone), fees and premiums, a borrower’s loan balance would continue to grow.
And remember how powerful compounding can be to grow your wealth over the years?
If you’ve ever struggled with credit card debt, you know that compounding works in reverse too.
A 65-year-old borrower in Wealthy Retirement‘s home city of Baltimore with a $300,000 home can receive more than $79,000 upfront from a reverse mortgage. Yet over the life of their reverse mortgage, they will pay nearly $18,000 in fees.
And that’s only if they own their house outright before taking on a reverse mortgage…
The fact is, less than half of even the market’s most “cash rich” borrowers are in that position by their 70th birthday.
But It Gets Worse
“No problem,” you might say. “Just pay off the loan on time, and you’ll go on your merry way.”
That’s where we hit a fatal snag…
Reverse mortgage borrowers have only one year after they move or pass away to pay off their enormous upfront allowances.
What’s more, if a borrower ever stops living primarily in the home or falls behind on property taxes, home maintenance or insurance during the life of their loan, the lender can come and demand their money back early.
Not to mention that if a borrower passes away before the loan expires, any heirs to the home are on the hook for the fees. In addition, any cohabitants who aren’t on the agreement could need to vacate the premises.
There are many provisions that protect the lender – and few that protect the borrower.
Chief Income Strategist Marc Lichtenfeld likes to compare reverse mortgages to annuities because they can be vague, dastardly and expensive.
And as with annuities, the spirit behind reverse mortgages can be downright dishonest.
You may remember that several years ago, annuity sales plummeted when the advisors who recommended them were required to act as fiduciaries (advisors who work in a client’s best interests).
The chart above shows the volume of reverse mortgages peddled leading up to the spring of 2018, when more restrictions were placed on sales. Most of those restrictions protected borrowers.
It’s clear that lenders are well aware of how dangerous these investments can be.
If you have no other way to fund your retirement and you have a large amount of equity in your home, you could look into a reverse mortgage as a way to afford high upfront expenses – but even in that case, it may be more prudent to downsize.
If lenders don’t have a vested interest in protecting you, it’s up to you to protect yourself.