Financial Planning
Financial Planning Magazine Online - Going Into Reverse - If a reverse mortgage makes sense for your client, it may make sense to apply now in case home prices fall further.
Several big banks have abandoned reverse mortgages this year, some watchdog groups have maligned them and consumers have shied away from them. Nevertheless, now may be a good time to recommend them to clients.
Reverse mortgages let those who are older than 62 tap into the value of their homes, often their most valuable asset. And although home equity has been falling since its 2007 peak, the National Reverse Mortgage Lenders Association and RiskSpan, a consulting firm, estimate that, in the first quarter of this year, those older than 62 still had $3.2 trillion in equity.
Dennis Loxton, a CFP and regional vice president of the reverse mortgage division of First Century Bank in Gainesville, Ga., says that reverse mortgages are most commonly taken out by low- or middle-income people to retire mortgage debt, free up liquidity or to pay for health care costs. But he's also seeing more affluent clients use them as a planning tool to fund long-term care and supplemental life insurance. "Their investments have taken a big hit, and if they have needs that have to be addressed, they're looking to their house to fund it," he says.
TIME IS MONEY - Reverse mortgages are a niche product: Only a tiny percentage of eligible homeowners opt for them. But if they make sense for your client, it's a good idea to lock them in soon, for several reasons:
* The industry's biggest player by far, the Department of Housing and Urban Development, which insures reverse mortgages through the Federal Housing Administration, plans to decrease the loan's limit at the end of 2011 to $417,000 from $625,500. * With property prices in certain parts of the country continuing to stagnate or fall, an FHA-insured reverse mortgage is one way to lock in a home's current value and protect its equity. * A reverse mortgage can be a financial lifeline for laid-off pre-retirees who are having difficulty finding new jobs in a weak economy. *
The exit of large lenders like Wells Fargo, Bank of America, Financial Freedom and SunTrust Bank means the future of reverse mortgages is unclear.
The exit of large lenders like Wells Fargo, Bank of America, Financial Freedom and SunTrust Bank means the future of reverse mortgages is unclear.
Loan volume fell in 2009 and 2010 from a 2008 peak, and 2011 is expected to be another down year, according to Reverse Market Insight. Concerned about overexposure to risk, Ginnie Mae, which purchases reverse mortgage-backed securities, tightened standards for its issuers last month.
Well-publicized lawsuits also have shaken the industry. Last year, the Illinois attorney general sued two mortgage brokers for unfair and deceptive marketing practices, claiming they implied these loans were part of a government benefits program and did not need to be repaid.
This year, the AARP Foundation Litigation sued the U.S. Department of Housing and Urban Development, charging that a 2008 policy change illegally forced some spouses of deceased borrowers into foreclosure after their homes had fallen in value. (HUD has since changed the rule). It also sued Wells Fargo and Fannie Mae to enforce rules that will let spouses and heirs of deceased borrowers purchase family homes at appraised value.
While these headwinds are unlikely to cause the reverse mortgage industry to disappear, in the short run they will probably have a negative impact. Some experts predict the industry will consolidate into a few big players that will take a closer look at the ability of applicants to pay for property taxes, homeowners insurance and upkeep costs before they grant a loan. Fees - often already steep - could rise, as well.
HOW THEY WORK - Homeowners can get a federally insured reverse mortgage if they meet the 62-or-older age requirement, are not delinquent on any federal debt, use the home as a principal residence and own it free and clear, or can pay off the balance of the mortgage with the proceeds from the loan. Since the loan is based on the value of the home, borrowers don't have to meet conventional underwriting requirements for income or creditworthiness. However, because a reverse loan is complex, they must first go to counseling on the benefits and risks.
They can choose a fixed- or adjustable-rate loan. But those who choose a fixed rate must take a lump sum, and start paying interest on the entire amount immediately. That makes sense if the money is needed to pay big bills right away, but if borrowers invest the unused amount at a lower rate than they are paying for the loan - perhaps in a savings account - they would lose the difference.
Owners do not have to repay the mortgage as long as they occupy the home (although under certain circumstances, the loan also can be used to sell one home and simultaneously buy another, eliminating one set of closing costs). The proceeds are tax-free.
The loan must be paid, with interest, when the borrowers die, move or sell the property, or if they don't pay property taxes and homeowner's insurance, or maintain the home. Any money left after the loan is satisfied goes to the borrowers or their heirs.
Borrowers need not be in good health to get a reverse loan, and having one does not affect benefits from Social Security or Medicare. However, clients should know a reverse mortgage can put a borrower above the asset limit for receiving needs-based government benefits like Medicaid, says New York lawyer Ira Salzman, who specializes in elder care law.
While applying for needs-based programs could seem a remote possibility to clients, in fact, 63.6% of nursing home residents were covered by Medicaid in 2010, according to the American Health Care Association. Planners should also be aware that laws and eligibility requirements for needs-based programs vary from state to state, Salzman says.
PROS AND CONS - A reverse mortgage can serve many purposes. Al Rodriguez, president of lender Gold Star Mortgage Financial in Longwood, Fla., says one of his clients, a 77-year-old, took out a reverse mortgage to buy a home down the street for her daughter. "That's a good idea," he says, noting the mortgage-free daughter will now be near enough to care for her mother, reducing her expenses.
He was not so enthusiastic about a reverse mortgage another client wanted to take out. At 69, the client wanted to make sure money would be available for his 64-year-old wife, should he die and their monthly income drop. Those who need the proceeds from a reverse mortgage now are well advised to get it, but if the need is years away, it's better to wait, Rodriguez says. That's because the older an applicant is, the more he or she will be able to get in monthly income. By June Fletcher
Financial Planners- Reverse mortgages should be first resort for advisers by Jeff Benjamin - Investment News
Vehicle may be the best way to stretch a retirement portfolio
Twenty-two years after they were introduced by the Department of Housing and Urban Development, reverse mortgages still aren't being used by most financial advisers as the viable retirement income vehicles that they can be.
Shunned as being too expensive, confusing and misleading to older homeowners, the reverse mortgage typically is considered a “last resort” by advisers.
But because they allow people 62 and older to stay in their homes and convert home equity into tax-free income, reverse mortgages probably should be an adviser's first resort. In fact, there are many times when a reverse mortgage can be the best way to stretch a retirement portfolio.
Consider, for example, a 75-year-old who is living in a mortgage-free home valued at $350,000 and has a $200,000 retirement portfolio.
Assuming a desired after-tax annual income of $27,500, a 6.5% annual retirement account investment return and a 2% annual home value appreciation, turning to a reverse mortgage first would generate total income of $590,000 and fund retirement for 19 years. Applying the same criteria to a last-resort strategy, which uses a reverse mortgage only after the retirement portfolio is spent, would fund retirement for 16 years with a total income of $500,000.
The $90,000 difference is created primarily by giving the higher-performing retirement portfolio more time to benefit from market appreciation. A third option, drawing down the retirement account, then selling the home but having to finance other living arrangements, would fund retirement for 16 years with a total income of $475,000.
The analysis was compiled with the help of Generation Mortgage Co., which clearly has a dog in this fight as the nation's largest independent originator of reverse mortgages.
But that doesn't make the results any less significant for a financial planning industry that is notorious for disregarding home equity as part of an overall financial plan.
Clearly, the reverse mortgage has its share of warts that will turn off many advisers. One of the biggest issues is the cost, even though all fees are deferred until the sale of the home, the death of the borrower or when the borrower moves out permanently.
In the scenario described above, a $6,000 loan origination fee, $2,000 in closing costs, a one-time 2% mortgage insurance premium, a continuing 1.25% mortgage insurance premium and 5.75% in interest on the loan would all be deducted.
The reverse-mortgage industry has tried to address the fee issues with some flexibility on the loan origination fees and a new “saver” option that spreads the one-time mortgage insurance premium over the term of the loan.
The saver option, which was introduced in October but has yet to gain much traction, is emblematic of the highly charged nature of reverse-mortgage decisions.
“This is a financial decision to be sure, but it's also an emotional decision because a lot of people are emotionally tied to a home they've lived in for 40 or 50 years,” said Harry Gordon, a branch manager at iReverse Home Loans LLC, a subsidiary of Hopkins Federal Savings Bank.
Multiple variables are used to determine how much equity a homeowner can receive through a reverse mortgage, but because the fees are typically deferred for years, the equity received always will be well short of a home's current market value.
Consider the example of a 69-year-old homeowner with a mortgage-free $500,000 home.
In a standard reverse mortgage, the homeowner would be charged a 4.99% interest rate and $12,600 in deferred closing costs. He or she would receive $316,000.
The saver option would result in a higher interest rate — 5.25% — but would decrease deferred closing costs to $7,500. The saver option has a lower loan limit because the mortgage insurance is deducted over the duration of the loan, not paid up front, and this homeowner's equity limit is only $249,000. In essence, the fees don't really change much; they just get moved around within the term of the loan agreement.
There is no simple answer as to why people might choose the saver option, which comes with a higher interest rate and smaller loan amount, except that it would save a few thousand on closing costs and allow the homeowner to keep more equity in his or her estate.
But the new twists in the saver option might be exactly what some financial advisers need to help their clients manage the emotional aspect of a reverse mortgage, which should be at least considered as part of a retirement income strategy.
For more Reverse Mortgage information please call (205) 908-2993 or Email Scott Underwood.
____________________________________________________________________
Harold Evensky on the New Rules for Wealth Management Robert Huebscher 7/12/11
If you don’t have a copy of The New Wealth Management on your bookshelf, you should. From gauging the risk tolerance of your clients to measuring the performance of their portfolios, this book provides comprehensive guidance for virtually every aspect of a financial advisory practice. Harold Evensky, the lead author, spoke with me last week and highlighted some key themes in the newly released second edition. Stephen Horan and Thomas Robinson co-authored the book with Evensky. Both are affiliated with the CFA Institute, and this edition is part of the CFA Institute Investment Series. As Roger Ibbotson noted in the foreword, 14 long years have passed since the original edition of this book came out. But as I will describe, very little has changed since then. I’ll look at some of those changes, as well as at what Evensky said about a controversial issue –annuities – and how it will play a critical role in financial planning. Lastly, I’ll explore a couple of topics you won’t find in this book.
Bridging a 14-year gap
The overarching message of this book is one that our readers already intimately understand: Advisors should act as fiduciaries, following well-documented precepts such as placing client needs first and avoiding conflicts of interest. That message resonates as clearly now as it did in the original edition. Evensky and his co-authors have introduced some new concepts in this edition to strengthen fiduciary relationships. One is the life balance sheet. It differs from a traditional balance sheet, where one compares client assets to liabilities, in that it includes implied components. Human capital is an implied asset that represents one’s earning potential, and one’s implied liabilities are determined based on one’s desired retirement goals. Another concept that Evensky said underwent significant updating is in the retirement stage of planning. He incorporated a concept called “squaring the curve” to account for the fact that people are living longer and healthier lives. “The assumption that as you get older, you’re going to spend less, may not be credible,”Evensky said.
When the original version of the book was written, expectations for returns from the capital markets were much higher than they are today. In this edition, Evensky has stressed the importance of adopting the context of lowered returns. “We’ve got some control over expenses and taxes,” he said. “We have no control over returns.”Investment expenses don’t go down with returns, Evensky said, and he advocates planning with the assumption that returns will be more modest than they have been for the last 70 years. Evensky expects real returns on equities to be 3% to 6% over the next decade. Evensky added a discussion to his book’s new edition about core-and-satellite investing – a discipline he introduced to the financial planning community over a decade ago. With this approach, advisors can construct the core portion of a portfolio based on lower return expectations and invest the remaining satellite portion once essential liabilities have been funded through core investments. He provided the following table to illustrate how clients’ inflation-adjusted spending will suffer, once expenses and taxes are considered in a low-return environment:
Practitioners agree that returns will be more modest than in the past, Evensky said, but very few look at the consequences.
The most important products for financial planning
With a fixed-immediate annuity (also called a single-premium immediate annuity), the investor pays a fixed sum today and receives fixed payments for life. Longevity insurance” annuity is one where the investor pays a fixed sum today and then receives fixed payments for life, which typically begin 10 or 20 years later. We reviewed one such offering
Before even talking about immediate annuities. He has completely changed his mind and now thinks two products – fixed-immediate annuities and longevity insurance are going to be “the most important vehicles over the next decade, largely because the products are now reasonably priced.”
The bucket approach
Financial planning, in which separate asset accounts (the buckets) are set aside to fund aspects of the client’s retirement. These aspects can be goal-oriented, such as for children’s education, living expenses and bequests, or they can be age-based. Evensky criticized this approach, saying that it has some “really serious fatal flaws.”He said these approaches may carry a lot of initial appeal for both the planner and the client, but the implementation is problematic. For example, if the buckets are age-based, some will be invested in equities and some in fixed income. Over time, however, those buckets need to be continually rebalanced, and asset allocations must be shifted as the client ages. Transaction expenses and tax drag will be too costly, he said, and there are too many moving parts for the approach to be effective.
What you won’t find in this book
Another topic not discussed in the book is macroeconomic analysis and how it should be incorporated into the planning process.
One is how to deal with inflation. There is a considerable discussion of TIPS, which Evensky uses in all his client portfolios. He manages his fixed-income allocations by keeping duration relatively short, and he uses a laddered approach with actively-managed bond funds. The book presents its analysis in terms of real, inflation-adjusted returns, but it does not discuss hedging against extreme events, such as very high inflation. Evensky said if he were to anticipate higher inflation or even hyperinflation, he would increase his allocations to commodities and natural resources. “We don’t plan for Armageddon,” Evensky tells his clients. “If it comes, all bets are off anyway.” Most clients just don’t have enough money to plan for Armageddon, he said. It is very easy to say you will protect against certain events, he said, but the problem is that after a crash, there will not be enough money for clients to achieve their goals.
Looking ahead
One example he gave are of reverse mortgages, which have been maligned in the media
and by many advisors. They are a tool that he is now reconsidering. Evensky teaches at
Texas Tech University, and he’s been working with his colleagues and graduate assistant
on a paper advocating the use of standby reverse mortgages as a way for clients to create
additional “standby” liquidity, analogous to a home equity loan.
“It looks like this is going to be an immensely powerful tool,” he said.
Tools such as reverse mortgages solve the problem that his cash-flow reserve approach
often requires clients to keep money in low-interest accounts. A reverse mortgage, even if
it is not drawn down, can reduce the amount of cash that is invested in that way.
In addition to the emergence of immediate annuities as a key planning tool, Evensky
expects mutual funds to come out with various types of built-in guarantees on their
products to help clients manage longevity risk and hedge against other adverse events.
Unfortunately, he said, there’s also going to be a lot of expensive “junk” offered, but that
will also create opportunities for advisors to add value by steering clients clear of bad
investments. © Copyright 2011, Advisor Perspectives, Inc. All rights reserved.
“Eventually advisors are going to wake up to the fact that they can’t afford to have all the fun and manage all the moving parts — buying and selling stock and being big Wall Street mavens,” he said. “There’s just too much cost in it and not enough return to justify it. So simplicity is going to be one of the stories.” www.advisorperspectives.com For a free subscription to the Advisor Perspectives newsletter, visit:http://www.advisorperspectives.com/subscribers/subscribe.phpI asked Evensky about a couple of topics that were not addressed in the book. One trend that has gained popularity among advisors is a “bucket-based” approach to Evensky said that when wrote his original edition; he would wash his mouth out with soap.
