House Rich, Cash Poor

People over 65 control a significant portion of the wealth in this country, but much of their wealth is concentrated in the equity in their homes. If Social Security benefits are excluded, just under half of all senior citizens would fall below the poverty line based on their income. Inflation continues to drive up the cost of food, energy, and, particularly, health care.

Federal budget cuts have pushed the cost of many programs down to state and local governments, driving up sales taxes and property taxes. These taxes, particularly the sales tax, tend to be regressive and really clobber retired people living on Social Security and limited resources.

The problem seems intractable. Seniors no longer work and if they went back to work they probably would not return to the work force in high paying positions; so an increase in income through additional labor is unlikely. Without additional earnings from labor, additional savings will be all but impossible.

Increasing the investment return on their savings may solve the problem for some seniors. However, many are unwilling to accept the risk associated with higher returns. Even if some are willing to accept the greater risk, their resources may be too meager for an increased return to make a difference. The only available asset may be their home, which most seniors own free and clear. Enter the "reverse mortgage."

Reverse mortgages literally are mortgage loans that work backwards. They also seem to violate most of the traditional principals of good lending practice, but more on that later. Under a reverse mortgage instead of sending a check to the lender every month to pay interest and reduce debt, the borrower receives a check every month from the lender and has his or her debt increase. Reverse mortgages vary from lender to lender but most have several characteristics in common.

First, they are generally available only to senior citizens (the definition of who is a senior may vary from 62 to 70 years of age) who own their own home with little or no debt. Next, the type of loan is usually either a term loan (with the term based on the life expectancy of the homeowner or a period certain) or a line of credit.

The amount of the monthly payment depends on the term of the loan, interest rates, the value of the home,and the percentage of current equity eligible to be loaned out. With a line of credit arrangement, there is no monthly check, the senior merely taps the line of credit for cash whenever necessary. Generally the loan is not repaid until the house is sold or at death.

The risks to the lender are obvious. With a loan based on life expectancy, they could loan more than they will be able to recover on sale. There is no current cash inflow. Given these and other disadvantages, its no wonder that lenders have not been flocking to offer reverse mortgages. The Federal Housing Administration has a loan guarantee program for reverse mortgages that is available, however it is subject to limitations.

The risk to the homeowner is also clear. The loan will eat away, and could wipe out, the value of their home. If the senior wanted to pass the home on to the next generation, that generation may be saddled with a sizeable debt.

Of course, this brief article is no substitute for a careful consideration of all of the advantages and disadvantages of this matter in light of your unique personal circumstances. Before implementing any significant tax or financial planning strategy, contact your financial planner, attorney or tax advisor as appropriate.