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Thursday, August 4, 2016
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Reverse Mortgages: Don't Let Fonzie (or Magnum, P.I.) Rip You Off!
Editor's Note: Last year, I wrote about how upset I was that washed-up TV stars like Henry Winkler were pitching reverse mortgages. I detailed why reverse mortgages are a terrible idea for most people. And now, another former star of years gone by, Magnum, P.I.'s Tom Selleck, has started hawking reverse mortgages.
His client, American Advisors Group, hopes that Selleck's devilishly handsome mustache will goad you into using an expensive financial product that can cause more harm than good. With Selleck's new job as pitchman, it seemed like the perfect time to revisit this article.
Why is it that washed-up TV stars from the 1970s and 1980s always seem to end up in commercials aimed at fleecing you?
Erik Estrada hawking real estate in California right before the housing bust? Sure, that makes sense. I don't think he's worked since CHiPs.
Alan Thicke promoting time shares in Las Vegas? I'm not surprised. I once got into an argument with him. He's a jerk.
But my heart broke when I saw Henry Winkler, whom you may fondly remember as "The Fonz" from Happy Days, peddling reverse mortgages.
Now let me say right upfront - I'm not a fan of reverse mortgages.
That doesn't mean they're a bad choice for everyone. Certainly, some people can benefit from them.
But let me explain why I believe that, most of the time, taking out a reverse mortgage is a poor decision.
Surely you're familiar with a traditional mortgage. You buy a house, take out a loan and pay off that loan each month.
A reverse mortgage is, well, the reverse of that.
With a reverse mortgage, you borrow money against the value of your home. You receive the money as a lump sum, a monthly payment or an equity line that you can draw on when you need it.
The loan balance is repaid only after you die or move out of the house.
Reverse mortgages are available only to people age 62 or older. You might choose a reverse mortgage if you're having a tough time making ends meet and you need a source of supplemental income.
After all, a reverse mortgage allows you to receive lots of cash, and you don't have to pay it back until you die (or move out). Sounds great, right?
Not so fast.
Fees, Fees and More Fees
These mortgage loans are typically expensive. They can cost thousands of dollars, much of which comes out of the money you receive.
In addition to the typical closing costs and title insurance fees that you'd pay to your lender, reverse mortgages include mortgage insurance premiums. (A regular mortgage would too if the borrower's down payment were less than 20% of the home's value.)
Typically, someone who takes a reverse mortgage would have enough equity in their home that they wouldn't need to pay traditional mortgage insurance.
But, with a reverse mortgage, that doesn't matter. They still have to pay the mortgage insurance.
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The insurance premium will be 0.5% if you take out less than 60% of the appraised value of the home and 2.5% for a loan of more than 60%. On a $300,000 home, that's $7,500.
You will also pay a mortgage insurance premium of 1.25% annually. But this fee doesn't come out of the sum you receive. Instead, it compounds over the life of the mortgage, and it's repaid with interest when the loan is paid back.
But, as they say on TV, "Wait, that's not all!"...
A monthly service fee of $30 to $35 is also deducted based on your life expectancy. So if your life expectancy is 100 months, that means an extra $3,000 to $3,500 will be deducted from the amount you receive.
Paying It Back
When you pass away, your estate has up to a year to pay back the loan. It cannot owe more than the home's value at the time the loan is repaid.
That can present a problem, though.
Let's say that when your heirs go to sell your home, it's a weak housing market and they have trouble selling it. Or they sell it for the appraised value, which matches what you owe on the loan.
After closing costs and 6% realtor commissions, they're in the hole. They still owe that money.
Here's an example. You owe $300,000 on a reverse mortgage. Your home is appraised at $300,000. Your heirs sell the home for the appraised value. They pay $2,000 in closing costs and $18,000 in commissions.
They receive only $280,000 at closing, and they have to pay the additional $20,000 out of their own pockets.
Let's consider another scenario - let's say you have to move out of your house and into an assisted-living facility. The rules are the same. You or your family has one year to pay back the loan (in most states).
Generally, assisted-living facilities aren't cheap. So, chances are, you and your family would need every dollar you could get from selling your house.
But if you owe a significant portion or all of your home's equity to the lender, it would leave little extra to pay for your care.
When Compounding Doesn't Work in Your Favor
And don't forget, a reverse mortgage loan compounds just like a regular mortgage does.
You know how when you bought your house with a $100,000 loan, you really paid back about $300,000 because of the interest over all those years? Same thing happens here.
The only difference is, with a regular mortgage, you're paying down principal and interest every month. With a reverse mortgage, you pay nothing.
Instead, all that interest compounds year after year. If you're fortunate enough to live a long time and stay in the house, that compounding adds up to a big sum of money.
The bottom line? Reverse mortgages can be a lifeline for retirees who are out of cash and have equity in their homes.
But for most people, they're not nearly as cool as Fonzie would have you believe.
The next time a washed-up TV star tries to sell you something, tell them, "Up your nose with a rubber hose."
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