Reverse Mortgages

I saw an article in Investment News about using reverse mortgages as a first source of capital for retirement income.  The article uses Generation Mortgage Co., a reverse mortgage originator, as a source.  My recollection was that reverse mortgages are better suited as an income source of last resort, and my skepticism was piqued by the use of an industry vendor as an expert.  The article did not go into great detail on how the conclusion was reached, so I constructed a little analysis.

The hypothetical retiree is a 62 year old male.  He has a home worth $250,000 and $500,000 of investable assets. He has no mortgage debt on the home.  Returns on the investment portfolio are assumed to be 4.5% annually, and home appreciation is expected to be 3% per year.  Origination fees are estimated at $7,500 and mortgage insurance is a one-time 2% fee, all of which is payable on the outstanding balance at the death of the borrower.  there is also an ongoing mortgage insurance premium of 1.25% of the outstanding balance.  allyA website associated with AARP, gave me an estimate of $731 per month in payments to the borrower under the program.  All Reverse Mortgage Company has interest rates posted on its site.  I used the higher of the two variable rates - 2.5%.  A Nationwide Income Promise(R) annuity that will pay $731 per month will require a deposit of $127,279.

The results:  For the first twenty years of retirement, using the reverse mortgage as the source of the $731 per month income stream results in a higher terminal net worth than buying an annuity with investable assets.  The advantage shrinks from 18% at the end of the first year to 5% at the end of year 20, but the advantage is still significant.  A reverse mortgage may be an appropriate income resource for a retiree.

Two big caveats must be mentioned.  The program that provides for a payment stream is only available with a variable interest rate.  An increase in the interest rate will have an adverse affect on the final net worth under the reverse mortgage scenario.  Second, no taxes affects were considered in the analysis as  there are too many permutations to consider efficiently.  That there is generally no tax on payments received from the proceeds of a reverse mortgage suggest that its advantage would widen.

A surprising result, so it was especially worth the effort.  It reminds me that I need to regularly check my assumptions about market conditions and the operation of financial products.

Special thank to David Gaynes and Dayna Adams.