it may surprise you to learn that some community bankers are quietly offering the loans, too, bringing a kind of Main Street respectability to a product that has long lacked it.
Pointer from Tyler Cowen.
Here is how I think of a reverse mortgage.
Step 1. Sell your house to the bank.
Step 2. The bank rents your house back to you.
Step 3. The bank forgives the rent, but instead charges you interest that accumulates until you die or move out.
Step 4. When you die or move out, the bank adds up the accumulated unpaid rent and interest. If you want to pay it up, you can get your house back. Otherwise, if the debt is higher than the value of the house, then it makes more sense to let the bank keep the house.
In principle, whether this works out financially depends on how long you live in the house relative to expectations at the time you take out the reverse mortgage. You want to live so long that the value of living rent-free in step 3 is so high that at step 4 you or your heirs gladly hand the bank the house rather than pay all that rent and interest. But if you move out or die relatively soon, the bank will have priced the mortgage in such a way that if you or your heirs pay off the debt the bank will come out ahead–and it will come out ahead even more if you give up the house.
Thus, as in any sort of life insurance or annuity situation, you are making a bet against the financial institution. My guess is that this is unwise.
1. In general, the individual loses bets against financial institutions. I tell my daughters, “remember that insurance companies always price to make a profit.” My point is not that you should never buy insurance of any kind. But you should always at least consider self-insuring (rather than paying for extended warranties, for example) or alternative ways of insuring.
2. I think that old people are inclined to over-estimate how long they will live in their houses. They do not like to think about how they might lose the ability to climb steps, to tolerate bad weather, or to live independently.
3. I do not think that many old people need to live rent-free in the short run. In the short run, you can just take out a regular mortgage and use some of the proceeds from the mortgage to meet the payments. Ten years from now, after you have used up most of the proceeds on making the payments and financing consumption, you can think in terms of selling the house. By that time you will probably want to. See (2).
My thing is if I can’t understand it in 10 seconds you probably shouldn’t do it. I don’t think many people like that.
Agreed. Also, if it is too good to be true, it probably is too good to be true.
Selling at a discount to equalize npvs. Don’t forget you are also paying for insurance to indemnify the bank against loss. It is as sure a certainty they will profit from it as anything.
” It is as sure a certainty they will profit from it as anything.”
Sigh. Should I just let all these go? I don’t know. Things are different because they are different things. Whole life annuities are worse than other kinds of annuities. Reverse mortgages are probably worse than regular mortgages. Banks can do good things and bad things. It’s not their job to decide which profitable things are good and which are evil, that’s our job.
The point is the risk is the insurers, not the banks. Baring the apocalypse, the bank will profit. It is a sure thing for them.
My mom had a reverse mortgage. The originator sold the note to a company that mostly operates as a collection agency. After she died, that company came at us with both barrels not long after her corpse was cold; a notice of default was put on her door the day of her funeral.
After reading the note, it was written in such a way that it was in in immediate default as soon as the person dies. We had 30 days to settle the note after getting the notice of default.
Since the note was relatively small compared to the price of the house, we wanted to simply pay it off so we could sell the house after fixing it up, but this outfit even made this quite difficult. Fortunately, we got the note paid off within a few days of the actual foreclosure process starting (after that, we would have owed a couple tens of thousands in legal fees as well as the note balance).
From their docs, it was clear that they simply wanted us to hand them the deed, or have them sell the house for us (doubtless for hundreds of thousands less than market value – the house is in Silicon Valley, not far from the new Apple HQ). They made it quite difficult to actually get pay-off wire instructions and it took two weeks to get it done.
Reverse mortgages strike me as having severe “agency issues”: the people who have to settle the mortgage are not the people who got it (even the collection agency’s customer service is top-notch to the people who got the mortgage).
My in-laws got a reverse mortgage and probably the simplest way of stating the program is it allows relatively new retirees to continue living the same lifestyle with retirement as opposed to cutting back. And what they are losing the money to pay for when they can’t live independently or inheritance to their kids or grandkids. It is probably a bad deal in the long run but the retirees may value the money a lot more between 65 to 75 versus paying it all at assisted living at 84.