Be careful how you use the proceeds
of that reverse mortgage

BY LEE KAPLAN—
What would you do with money from a reverse mortgage? Take a trip around the world? Buy a new sports car? Go to 'Vegas and put it all on red? Well, you could do any of these things with the proceeds of a reverse mortgage, but maybe there's a little voice in your head telling you it wouldn't be such a good idea. You should listen to it.

A reverse mortgage does makes extra cash available from your home equity without requiring you to sell your home and move out. And there are no restrictions on how you use the proceeds of the loan. However, since you'll be giving up a lot — maybe even all — of the equity you've built up in your home over your lifetime of ownership, you'll want to use it wisely.

Reverse mortgages are very complicated products and are not for everyone. (See "Reverse mortgage basics.")

A reverse mortgage can be a lifeline for people with few or no other financial assets. It can provide money to help you stay in your home by making "aging-friendly" home improvements or by hiring some extra help for tasks you can't do yourself anymore. And if you plan to remain in your home for many years, it can make financial sense.

However, unless you're a high-stakes gambler, you don't want to risk the loss of this money. Keep in mind that you'll need to be able to pay your property taxes, insurance, and home upkeep to continue owning your home.

Investments

One thing you'll probably never want to do is pay the high cost of a loan like a reverse mortgage to fund an investment. Given the high closing costs and fees of these loans (sometimes as much as 5% to 7% of the value of your home), you'll be unlikely to find an investment that returns enough to make it worthwhile without taking on excessive risk.

A 2007 survey of borrowers of reverse mortgages by AARP found that, while investments were not a primary reason for most people to take out a reverse mortgage, this practice is not unheard of. One in seven borrowers indicated that they had looked into a reverse mortgage for the purpose of making investments. About 9% reported that their lenders had recommended specific financial services products. In the end, 4% of borrowers said they had actually used their loans for this purpose.

Several state attorneys general have noted cases where some marketers of financial products like annuities have marketed reverse mortgages as a way to promote these investments. This is a questionable strategy on at least two fronts.

First, the return on an annuity over and above the cost of the reverse mortgage is unlikely to provide much real return. And, second, if your goal is a predictable monthly payout, you can take the proceeds of a reverse mortgage in regular, monthly payments, without the added cost of purchasing an annuity. Using your home equity (and perhaps your children's inheritance) for this purpose is not something you'd want to do without careful consideration together with your heirs and discussion with a trusted counselor.

A recent article in the New York Times describes one borrower's problems with a reverse mortgage that was channeled into an annuity.

With the subprime mortgage market imploding, some in the lending industry see reverse mortgages as a new source of income. Be on the lookout for high-pressure marketing on behalf of this product. The U.S. Senate Special Committee on Aging is considering legislation to protect seniors from high-pressure sales tactics and require more disclosure. Sen. Herb Kohl of Wisconsin noted, "When used properly, reverse mortgages can be an effective way for seniors to tap into the equity of their house. But too often these products are not used effectively and seniors end up losing their homes."

Long-term care insurance

The decision to fund long-term care insurance with a reverse mortgage is somewhat less clearcut. If using a reverse mortgage provides enough funds to enable you to afford long-term care insurance, under the right circumstances, some financial advisors (and the reverse mortgage industry itself) feel it could be a wise use of the loan. However, many advise caution.

Harriet Veenker, a financial planner with North Woods Retirement Services in Aitkin, Minnesota, says, "Using a reverse mortgage to purchase long-term care insurance only makes sense to me if the other suitability criteria for purchasing long-term care insurance are met (income, assets, ability to tolerate premium increases, etc.). Also, one's health must be good (long-term care insurance is tougher to get than life insurance), and one should consult with a financial advisor and an attorney to be sure that long-term care insurance makes sense."

She sees other, more common uses than long-term care insurance for a reverse mortgage. "Normally people who are interested in reverse mortgages have similar situations. Most often, cash flow is very limited, for a variety of reasons: health care costs, death of a spouse, long-term care needs, inflationary pressures on a once adequate budget, etc. Sometimes a reverse mortgage can fund the needs and desires of a terminally ill person, especially if he or she is on a limited budget and doesn't have life insurance. No matter what the reason, a reverse mortgage is best suited to those who intend to and are able to remain in their home for several years."

It's not enough for you to be able to fund initial premiums of long-term care insurance. If you can't pay the premiums up to the time you need the benefits, you'll lose the policy (and all the premiums you have paid in). So, you need an accurate forecast of your cash needs over the long run (with an adequate cushion for unforeseen events). This is where a qualified and trusted financial planner will be very important.

Financial 'trump card'

Stuart Schmitz, an elder law attorney with Schmitz & Schmidt in St. Paul, Minnesota, agrees that long-term care insurance is usually not a suitable use for a reverse mortgage. He sees a poor match between the reverse mortgage and long-term care insurance. "The reverse mortgage is your financial 'trump card,' so you shouldn't play it until you absolutely need to. In cases where someone is property-rich and income-poor, a reverse mortgage can help the person stay in the home. However, for the most part, people who would use a reverse mortgage are not the type of people who would be good prospects for long-term care insurance, because they don't have the assets required to pay for it."

So, unless your assets can support long-term care insurance premiums without a reverse mortgage, it's probably not a good idea to rely on one to fund this insurance. If you can't pay the premiums over the life of the policy — and that could be many years — you'll lose the money you've put into it.

He often recommends as an alternative approach for clients whose children are in a financial position to lend funds to parents who need extra income, that the parents borrow money from their children, with the loan secured by a promissory note and mortgage. "A reverse mortgage is a limited idea for limited circumstances. Using it to purchase other financial products, like long-term care insurance, is generally not a good idea," Schmitz says.

This points up the need to consult with independent advisors before and during consideration of a reverse mortgage. A reverse mortgage might be a good option for you, but you need all the facts. You may not get them from the person selling you this loan product, who is not in position to assess your personal and family situation.

(Posted: March 6, 2008)