Reverse Mortgage Nonsense

Reverse Mortgage Overview

One of the things I hate is when a celebrity uses his fame to try and sell something to an unsuspecting public.  The one that brought this to my attention is Tom Selleck from various TV shows (Magnum PI fame, along with other shows over the years).  The problem is that many unsuspecting people are willing to believe that this famos person would never lie to them, especially after he says he woldn't lie - through his teeth.

The product being sold is a reverse mortgage and is aimed at people over 62 years old and the problem is that this is a terrible option, no matter how you look at it.  A standard mortgage, assuming your are working and bringing in income, requires that you make monthly payments to whomever is the mortgage holder.  A brief recap of a mortgage may help - a mortgage is a loan made to the borrower (home owner) and uses the home as collateral while the mortgage is being paid off.  Here a simple truth, if someone is going to loan you money then they will want to be paid interest for the use of the money and that makes sense because if you had the money sitting around, you would not need to borrow the money.  Interest is a payment for the use of the money, nothing else.  Many people become offended with the idea of interest but the simple truth is that they did not need to lend you the money and they do not want a favor from you in the future, they simply want you to pay for the use of the money.  The way it works is simple and nothing personal - you request a loan amount and they figure out what payment would be required for the loan to be paid off in the time period desired, most frequently is a 30 year (360 monthly payments) loan.  This is very easy to figure out if you have a computer and an excel worksheet.  If you set up a worksheet then you can see the amount that is allocated each month to interest and how much is payment of the loan amount (principal). 

Setting up the worksheet (if you don't care then skip to the next section).  In order to make this work, you need to know how much is the amount borrowed (principal), the interest rate and the number of months because 360 is a default but not fixed.  The first column needs to be the month counter (just to be sure) and starts with 1 and then each row adds 1 until you get to 360.  The next column is the remaining principal so put the borrowed amount on the line for month 1 (just to set up the worksheet, start with $150,000, let's get the first row entered before worrying about anything else).  In the next column, enter the interest rate, a 5% interest rate is entered as 0.05 so let's use this as a sample until the worksheet is set up.  The interest rate is tracked because an ARM has a variable interest rate, however, a fixed rate is always the same so it won't hurt anything.  In the next column 'D', enter a dollar amount to project the monhly payment, once again, on an ARM this amount can change as the interest rate changes, use $800 to start with, don't react to anything until we see if the formulas work.  In column 'E' enter a formula for the monthly interest charge, remember the interest is charged on the remaining amount of the loan, not a fixed amount every month.  For the first month, the interest is charged on the amount you entered in column 'B' (principal), so the formula is very simple: column B * column C / 12.  The answer is the amount of interest for the first month.  In the mext column enter the amount of principal paid for the first month, so the formula is: column D - column E.  This is the amount of principal that was paid for that month.  Now start on the second row, if this is done right then you can just copy the next row down from 3 to 360.  Column B(#2) is a formula of Column B(#1) - Column F(#1).  Column C#2 needs to be the same as Column C(#1) so the formula is Equals C(#1).  Column D(#2) needs to be the same as Column D(#1) so use the same formula Equals D(#1).  The formulas for column E(#2) and F(#2) can just be copied from E(#1) and F(#1).  Now all the formulas should be in place so copy the formulas for row #2 into the row for #3 and it should look like:

1      150,000.00          0.05      800.00      625.00      175.00

2      149,825.00          0.05      800.00      624.27      175.73

3      149,649.27          0.05      800.00      623.54      176.46

Now copy the formulas for row #3 to all the rows through #360 and check the amount showing in column B(#360), is it 5,133.35?  Hopefully it matches which means all of the formulas now work.  What this means is that a 30 year loan paid off at $800 per month using a 5% interst rate has a balance due of $5,133,35, proving that the assumptions were slightly off, how can you zero into the exact amount?  Before doing anything else remember one thing, the amounts showing in line #360 are based on the last payment so the pincipal in column B(#360) should equal the amount of principal paid in the last payment because the principal balance  is at the beginning of the month and the payment is at the end of the month, and yes, it makes a difference.  Now go back to the Row #1 and use $805.23 in column D and see what the final total is when you subtract the last Principal payment (F) from the Principal balance (B), hopefully it is pennies off.  This is way to find the number by guessing but there are actually formulas in excel, however, this worksheet allows you to predict the amount of interest that is paid every year along with the principal balance at any time.



With a standard mortgage and the worksheet from above, you can see what the principal balance is on the mortgage at any time during the 30 year life so if you decide to sell the property or refinance then you know what your starting numbers are.  To understand the concept of equity, you need to understand that the equity is based not on what you paid for the house but what it is worth at this moment in time.  Most of the time, property values go up slowly over time so the sales price in 5 years could be 10% more than what was paid but it can also be 10% less depending on the market.  Every property value is based on what the market (all buyers taken as a whole) would be willing to pay for that property right now, and this changes over time.  By looking at the worksheet, you know what the remaining principal is at any point in time and if you subtract that amunt from the market value, you have a rough approximate value of the equity in the property (how much you actually own).   The current estimated value of most properties can be found on-line in one database or another.  This is the equity value of the home to the owner and as long as the market remains consistent, your principal loan balance will continue to drop as each payment is made, the goal is to get the loan down to zero so you own the property.  

This is how a standard mortgage loan works and could require 30 years or more to pay off the loan or it could be paid off earlier, depending on the payments made.  The goal is to pay off the loan so you do not have an outstanding balance, however, your obligation does not go away just because the loan is paid off.  On each property, you will need to pay for the insurance and the property taxes assigned to the property.  





Here is where the variations come in, well, in fact there is very little difference it is just the direction of the money flow.  In every mortgage, the goal is to pay off the loan so the property is 'free and clear' and can be passed on to the heirs without debt.  A reverse mortgage simply puts the loan balance back on the house so it can't be passed 'free and clear'.  A reverse mortgage simply means that you, as the owner gets money and the reverse mortgage company place a lien on your property.  The reverse mortgage has repayment stipulations also and if you fail to make the payments then the property can be foreclosed and repossessed.  The sales pitch from people like Tim Selleck sound good but is mostly nonsense, these people want your house and will wait for you to be forced to sell to them.  Just like a regular mortgage, there is iinterest and this adds up and compounds over time.

Before considering a resverse mortgage, you need to sit down and make long term decisions as to what will happen with the property.  If you plan on selling it sooner or later anyway, then forget the reverse mortgage and simply sell the property and buy something smaller and more in line with your needs over the coming years.  If you want to keep the property in the family, who is going to end up paying off the reverse mortgage?

The big question is simple - who do you want to own the property in the long run.  The reverse mortgage company wants to lend you money and they want to accumulate the interest so they will be able to foreclose on the property, that is their plan.  You must understand that every property is expected to go up in value over time however the amount of the loan won't go up so the reverse mortgage company is planning on getting the property and selling it.