Wednesday, March 26, 2014

Mathematical Example that Shows when a Reverse Mortgage is a bad idea.

Example 1, when Reverse Mortgages are a bad idea.

Retired couple wants to supplement their social security income by withdrawing 500 dollars a month against the value of their paid off $500,000 home via a reverse mortgage. They consider this to be a 20 year plan.
Unfortunately, the entire value of the home will be absorbed after 17 and 2/3's years in the following manner. The couple will get $106,500 in 500 dollar monthly payments while accruing interest rate charges on the money taken out by the couple plus the mortgage insurance premiums will be approximately 393,500!
I used a mortgage insurance premium interest rate of 1.5% on the full value of the home (it can be as high as 3% and perhaps down to 1.25%) plus 7.5% interest rate charge on the entire equity that has been taken out of the house (meaning mortgage insurance premiums on the full value of the house plus the modest monthly draw being taken out by our frugal, retired couple) for my calculation.

Now it is possible that the home may go up in value during that 17 years time. However, will increase in home value be absorbed by a higher and higher mortgage insurance premium amount as the value of the home rises? If the answer is yes, than a long term reverse mortgage may be a horrible long term program.

So when is a Reverse Mortgage "acceptable"? I don't know all the examples but three that come to mind would be, home is about to be lost to foreclosure and the Reverse Mortgage prevents that from happening. 

A second example would be Reverse Mortgage is used for needed home improvements so the home is more easily sellable in the near future.

A third example would be for whatever reason, getting a large chunk of money out right away while still being able to live in the home for a "while" is desired.

In my opinion, think of Reverse Mortgage as a short term plan, probably for most people 5 years or less would be my guess, but keep in mind that even if the home is sold within five years, there will still be signifcant amount of equity that went to the mortgage insurance and interest rate charges charged on whatever equity was converted to cash.

A HELOC is probably a more superior financial product but the government in their questionable wisdom has basically shut out 99% of all retirees from being eligible for a HELOC based on their social security income. It appears that Dodd / Frank bill is to blame for this.

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