Friday, November 13, 2009

Consumer Reports alarmist on reverse mortgages

(Warning: non-sports post.)

In their September issue, Consumer Reports issues another muddled panic about a financial product; this time it's reverse mortgages.

Basically, a reverse mortgage is a loan you take out using your house as collateral. Normally, you'd do that with a line of credit -- you borrow the money as you need it, and make at least your minimum payment every month (as interest accrues). It's like a credit card, but with a much lower interest rate because it's backed by your house.

The reverse mortgage is also a loan on your home equity, but it's meant for poorer elderly people who don't have the income to make payments on the loan. With the reverse mortgage, you still get the loan, but the interest accumulates and compounds, and you don't have to pay it back until you move out of the house (or die). The idea is that when you're no longer living in the house, you sell it and use the proceeds to pay off the loan.

What if the loan has compounded so high that the value of the house isn't enough to pay it off? In that case, the borrower is off the hook. One of the benefits of the reverse mortgage is that the borrower is never on the line for more than the house itself.

As CR points out, this benefit has a price: the borrower winds up paying for "insurance" against that happening, insurance that tops up the loan if the house is eventually not worth enough. It's government insurance, and comes with government regulations on reverse mortgages. For instance, you have to be over 62, and you have to do lots of expensive legal paperwork.

It's called a "reverse mortgage" because it's often taken out to provide a stream of payments to supplement social security. That stream of payments is backwards from a normal mortgage: instead of you paying off the mortgage every month, the mortgage pays you.

My feeling, and CR's too, is that a reverse mortgage is a reasonable thing to do if you plan to stay in your house forever, and won't need money afterwards (because either you've died, or you're so ill you move to a nursing home paid for by government). Why die with money in the bank (or equity in your house)?

Another benefit of the reverse mortgage is that it sometimes it can provide the only way to get a lump sum of money in case of sudden need, like a medical emergency.


So what's CR's problem with reverse mortgages? They have a few. Some of them are not completely unreasonable. CR gives stories of people being sold expensive reverse mortgages in order to use the money for inappropriate investments, which is certainly a bad thing. But that's not the fault of the reverse mortgage -- seniors are sold questionable financial products all the time, and sometimes persuaded to borrow money in other ways.

And CR gives examples of seniors who didn't really understand what they were getting into. For instance, sometimes salespeople hand customers overoptimistic projections of what their house will be worth, misleading them about the amount of equity that will be left for their children to inherit. But, again, biased salespeople are hazards of any financial transaction.

CR is also concerned that due to the housing meltdown, a lot of reverse mortgages end in the red, where the government-sponsored insurance comes into play. The payouts have started to exceed the premiums paid by borrowers, and CR is concerned about the burden on the taxpayer. It could be "the next financial fiasco."

I don't really understand their concern. In 2008, the worst year of the housing crisis, the fund only had to pay $400 million in claims. Suppose they pay at that rate for five years. That's about $6 per American. Compare that to the $7 trillion bailout, which is $13,000 per American. Is it really worth worrying about a $6 "fiasco" while ignoring the $13,000?

Not only is it a small amount of money, but you could argue that it's money well spent. Reverse mortgage insurance money is not a gift to the irresponsible: it's part of a social program that allows senior citizens to hold on to their homes, while living better in their old age. I'm not a big fan of government spending, but such a small sum, for such a good purpose, as the result of once-in-a-lifetime anomaly in housing prices, is probably 1000th on my list of government policy issues people should be concerned about.


But the thing that *really* bugged me about the article is the lead anecdote that purports to show the human side of why reverse mortgages are harmful. But, as with their medical credit card screed last year, they got their conclusion completely backwards! Their example actually shows a reverse mortgage that handsomely rewarded the borrower.

When Ernest Minor was 61, his wife had serious medical problems. The Minors still owed $70,000 on their home. They took out a reverse mortgage loan for $176,000. $70,000 of that simply replaced the outstanding mortgage balance. $15,000 went for fees and insurance. And $92,000 went to pay the medical bills.

Because Mr. Minor was not yet 62 (but his wife was), they had to transfer the deed to Mrs. Minor's name in order to be eligible -- which they did.

Mrs. Minor died two years later. That made the loan come due. With interest, it's about $200,000. Obviously, Mr. Minor can't afford to pay that, so he will lose his home.

Sure, it's sad that Mr. Minor will lose the house he lived in for so many years. But, after all, he needed $92,000 for medical bills. Without the reverse mortgage, what would the Minors have done? They'd have sold the house, rented an apartment, and used the proceeds to pay the bills. They would have lost the home immediately. But, with the reverse mortgage, they got to live in the house a couple more years. Plus, if Mrs. Minor had gotten better, they would have been able to stay there indefinitely! Of all the Minors' options, the reverse mortgage was, in fact, the very best way to handle the situation.

CR is upset that the broker had Mr. Minor take his name off the deed to get the loan -- if he hadn't, he'd still be allowed to stay in the house until he moved out. But, unfortunately, government regulation gave him no choice! Instead of picking on the salesman, maybe CR should lobby the government to lower the minimum age, or at least allow one of the spouses to be under 62.

Anyway, Mr. Minor benefits even further. He owes $200,000. But because of the real estate meltdown, his home is only worth $130,000. You'd think he'd be in the hole to the tune of $70,000. But he's not! Remember, with the reverse mortgage, you can't owe more than the house is worth. Mr. Minor can walk away, because his $70,000 deficit is covered by the insurance he bought!

Let's do an accounting. Suppose that before the real-estate crisis, the house was worth $300,000 (which is about right, based on what CR tells us about what percentage of the home's value is loanable). If Mr. Minor had raised the $92,000 some other way, via a conventional loan, he'd be liable for that $92,000. He'd still owe $70,000 on his mortgage And he'd have made maybe $20,000 in interest payments over the three years on that $162,000.

So his total owing would be $182,000. His house would be worth only $130,000. His net worth would be negative $52,000.

But, with the reverse mortgage, he just walks away! He loses the house, but his net worth is $0. The reverse mortgage saved him $52,000! Of course, most of that savings came from avoiding the housing crisis, but still -- rather that Mr. Minor being a reverse mortgage sob story, he should be a success story!

CR prints a half-page photo of a sad Mr. Minor, holding a photo of his deceased wife. It's indeed very sad and moving that the illness lost him his wife and his house. But the reverse mortgage was the lone, small bright spot. It wound up saving Mr. Minor thousands and thousands of dollars. And CR didn't even notice.



At Monday, November 16, 2009 1:04:00 AM, Anonymous milobloom said...

Would you be interested in adding a link to my Curling blog? Curl with Math

Also, I'd be interested in your thoughts.


At Monday, November 16, 2009 1:20:00 AM, Blogger Phil Birnbaum said...

Hi, Milo,

Sure, I've subscribed to your blog, so I'll get new posts. I'll read the back posts as soon as I can. Not a big curling fan, but i think I can probably figure out most of it.

At Monday, November 16, 2009 2:15:00 AM, Anonymous milobloom said...

Great, now if I can only figure out how to add links. I'm using an old version of Wordpress (hosted by the Curlingzone guys). Would you suggest another option? I need to incorporate graphics but can't figure it out.


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