Mortgages, Forward and Reverse
Home ownership has always played a significant role in the American Dream. Especially among those who watched people they knew lose homes during the Depression, paying off the mortgage became an almost universal aspiration. The lesson learned was that paying rent was just wasting money; the best approach was to buy your home and pay it off as soon as possible. In fact, it wasn’t unusual to have a mortgage burning ceremony to celebrate making that final payment.
The preference for buying over renting has also been influenced by various actions of the US government. Following the Depression and the associated home losses, federal agencies were created to help resuscitate the housing market. Known as Ginnie Mae, Fannie Mae and Freddie Mac, they provided liquidity and insurance to the marketplace. After World War II, elected officials felt that encouraging returning veterans to buy homes would be a good way to get the economy moving. That led to the GI Bill and the broadening of the mortgage interest deduction which provided additional incentives for purchasing a home.
However, times (and government policies) change. As planners, we encourage our clients to consider all housing options to find the one that best meets their needs. For example, the 2017 Tax Cut and Jobs Act capped the amount of tax benefit available for first mortgages and it eliminated the deduction for second mortgages (HELOCs). Such changes may make ownership somewhat less appealing, perhaps enhancing the idea of renting.
In my nearly thirty years as a financial planner, I regularly encounter situations in which renting makes sense. At such times, I help my clients consider what their rent payment might actually ‘buy’, rather than assuming it’s a waste of money. Some possibilities include:
• freedom to move on short notice
• a place to live while money is saved for a down-payment or while waiting for the right home to come along for purchase
• freedom from maintenance and property tax worries
• a more carefree lifestyle, perhaps living in a vibrant downtown metro area
• avoiding potential complexities for heirs who might need to deal with probate in multiple states.
Still, for many, home ownership is not only part of the dream but a very sensible approach from a financial planning perspective. We believe most people are best off owning multiple asset classes, including stocks, bonds and real estate. While appreciation in home values doesn’t generally doesn’t outpace other types of investments, it does require systematic payments, something that doesn’t always happen with investment accounts. A recent survey released by the Bank of the West, suggests that Millennials have begun borrowing from retirement accounts to fund home purchases – a strategy we do not agree with.
Since few people hit the housing market with enough cash to buy a home outright, a mortgage becomes their path to ownership. In common usage, a mortgage is the loan used to finance the purchase of, or improvements to, a dwelling. This can include homes, condominiums, co-ops and even boats and recreational vehicles under some circumstances. These days, there are lots of places you can buy a mortgage, including websites and storefront offices. But, in order to get the best deal for each of our clients, we work only with local banks and credit unions.
The ‘forward’ mortgages I mention in today’s title are the conventional loans that most of us are familiar with. These come in many flavors, so being sure what you want your mortgage to accomplish is important. Many elements of a mortgage are either negotiable or vary significantly from lender-to-lender. Options such as low closing costs, an interest-only payment, a low initial rate or the ability to pay down a mortgage to reduce the monthly payment will probably be available from one institution or another. Shopping around for the right features and best rate is part of the process we use for our clients but you can do the same thing yourself by making some phone calls. When rates were at generational lows a couple years ago, we completed lots of refinancing projects for our clients. Now that rates have risen, that idea isn’t quite as compelling but the need for one or more of those other features might still make a new mortgage a reasonable idea. Once we know what the goal is and how it fits into a client’s overall plan, we begin trying to locate the best deal.
Reverse mortgages were a terrible option for many years but recent updates have made them worth considering in several circumstances. For those who are house rich but income poor, a reverse mortgage might be the best way to access additional monthly cash. In some cases, using a reverse mortgage to drop the mortgage payment to zero is enough to balance the monthly budget – something we insist upon for all our clients. Those whose budget balances but who find themselves in need of additional income to cover long-term care costs can also look to a reverse mortgage to withdraw tax-free money from the accumulated value of their home. In some cases, this can be a replacement for a traditional long-term care policy. Finally, those who are taking IRA withdrawals to cover living expenses might be able to reduce their taxes by using the non-taxable proceeds of a reverse mortgage-based line of credit as a source of income.
Reverse mortgages can be expensive to initiate. There can be complications associated with them, just as there are for traditional mortgages so it’s important to do your homework before making a multi-hundred-thousand-dollar decision. And, as always, we urge you to avoid any financial product endorsed by someone who used to be famous. You can certainly do better elsewhere.
As planners, we don’t favor any one of these approaches over the others. It’s our experience that one of them will be the best choice for a specific client in her or his unique situation. Are you familiar with our slogan: ‘Financial advice as individual as you are’? That’s how we approach all planning questions, mortgage-related or not.