Don’t use a reverse mortgage to pay off your existing mortgage

Some of the vilest companies promote the use of reverse mortgages to pay off an existing regular mortgage. Not only does the interest change from being deductible to non-deductible, the rate itself usually jumps. Because you are no longer writing checks you do not notice the harm; of the higher rate, the lost deductions, and the costly new arrangement.

For example, assume you still owe $100,000 on a mortgage with 10 years remaining and a 3.5% interest rate. Your monthly payments would be about $989. To get rid of these payments, you consider getting a lump sum reverse mortgage with a 5% interest rate. Using H.U.D. (the U.S. Department of Housing and Urban Development) guidelines, depending on your home value reasonable closing costs might be as low as $7,290, but they could be much more – well over $10,000. Assuming the best case, to pay off the $100,000 regular mortgage balance you would need a reverse mortgage lump sum advance of $107,290 – the payoff amount plus closing costs.

During the next 2 years, your regular mortgage would require about $23,732 in cash payments. Those payments would reduce your mortgage balance to $82,694. About $17,306 of your payments remains a part of your wealth in the form of increased home equity. If a marginal tax rate of 25% is assumed, $1,606 of the interest expense comes back to you through tax savings. Thus, the net cost of your regular mortgage would be about $4,820.

With a reverse mortgage, the costs provide no tax benefit, and your balance would grow to $121,536 in those same 2 years. You saved about $22,126 in after-tax cash flow, but those cash savings cost you about $39,000 in home equity – the extra $21,536 you owe plus the $17,306 you would have paid off had you stayed the course with your regular mortgage. The reverse mortgage worsened your financial condition and net worth by almost $17,000 in just 2 years. And it gets worse.

comparable mortgage costs

After 5 years, the regular mortgage would have an after-tax cost of about $10,267; the reverse mortgage cost would surpass $46,000. In 10 years, the regular mortgage cost peaks at just under $14,000. At that time you would own your home free and clear. With the reverse mortgage, at that same time your cost would surpass $100,000 and you would owe the bank more than $200,000.

To put the financial harm in more concrete terms, assume your home has a market value of $300,000 with the outstanding 10-year mortgage described above. You are considering paying off this mortgage with the reverse mortgage also just discussed. At some point you might move or your home could pass to heirs and the mortgage would have to be settled. With either mortgage, where will you stand? For simplicity and ease of comparison assume no other costs or tax differences upon the transaction.

mortgage impact on home equity

After 10 years, as just discussed, had you kept paying your regular mortgage you would own your home debt free. Selling it at this time would reap all $300,000 of its value. Subtracting $118,663 in payments you made over the decade renders net cash flow to you of $181,337. If instead you refinanced with the reverse mortgage, upon the sale of your home you would have to pay a loan balance of about $200,118, leaving you with net cash flow of $99,882. The reverse mortgage worsened your financial situation by $81,455.

Going forward, it gets tragic. After 16 years, had you stuck with your regular mortgage, you would have made no further payments for 6 years and, of course, still owned all of your $300,000 home. If you refinanced via the reverse mortgage, with no additional cash flow or benefit whatsoever, the loan balance would climb to over $290,000. Selling your home would net less than $10,000. In just a few more months, the bank holding your reverse mortgage would own all the equity in your home.

In the long run, there is great likelihood that refinancing a conventional mortgage with a reverse mortgage is really just a delayed sale in which the refinanced amount is all you will ever get for your home.

Get the whole picture. Read The Final Rip-Off: Reverse Mortgages available at Amazon and Barnes & Noble.

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