REVERSE MORTGAGE INFORMATION: Tools, News and Resources to Help Seniors Decide

[tag]Reverse annuity mortgage[/tag] is a phrase with dual meanings. Most users of the term are simply referring to a basic [tag]reverse mortgage[/tag]. One of the payment options available to reverse mortgage borrowers is the tenure payment option which acts very much like an [tag]annuity[/tag]. Under this option. homeowners receive fixed monthly payments – comparable to annuity payments – for as long as they live in the home, even until death.

Here’s a typical definition found at Investorwords.com:

reverse-annuity mortgage

Definition
An arrangement in which a homeowner borrows against the equity in his/her home and receives regular monthly tax-free payments from the lender. also called reverse mortgage or home equity conversion mortgage.

But a second (and more precise) defintion of reverse annuity mortgage is found at AARP’s Glossary of Reverse Mortgage Terms:

reverse annuity mortgage – a reverse mortgage in which a lump sum is used to purchase an annuity that gives the borrower a monthly income for life.

This second use of the term refers to something much different than above. Under this scenario, the homeowner takes the reverse mortgage proceeds as a lump sum payment (as opposed to tenure payments) and purchases an insurance company annuity product.

Why would a homeowner buy an insurance annuity in lieu of taking tenure payments? There are two main reasons:

• First, monthly payments under an insurance company annuity continue for life, regardless of whether the homeowner stays in the home. Senior homeowners sometimes find they must sell due to health or other reasons, even though their intent when taking out a reverse mortgage was to remain in their home the rest of their lives.
• Second, many annuities can be invested in stocks and other assset categories that may produce higher monthly payments than available through a reverse mortgage.

On the other hand, monthly reverse mortgage payments will not be subject to federal income taxes whereas at least a portion of monthly annuity payments will be taxable.

So, is it a good idea to purchase an annuity product with reverse mortgage loan proceeds? It depends. Annuities are a complex financial instruments unto themselves. There are many variations – immediate annuities, deferred annuities, variable annuities, etc. – each with its own idiosyncracies and pitfalls for the unwary. In the right circumstances, a reverse annuity mortgage combination can be beneficial. But it will take a lot of homework and independent expert guidance to help a homeowner make the correct decision.

One thing that can be said with certainty is that it is never a smart idea to “bundle” a reverse mortgage transaction and annuity purchase together. A favorite tactic for reverse mortgage fraud artists has been to combine the two complex, hard-to-understand transactions in a manner that takes advantage of the senior homeowner. In some cases, abusive lenders have told seniors that the purchase of an annuity was a “requirement” for obtaining a reverse mortgage. After experiencing many such reverse annuity mortgage fraud cases, California recently enacted legislation specifically prohibiting this practice. Under the new law:

A reverse mortgage lender or a broker arranging a reverse mortgage loan shall not:

(1) Offer an annuity to the borrower prior to the closing of the reverse mortgage or before the expiration of the right of the borrower to rescind the reverse mortgage agreement.

(2) Refer the borrower to anyone for the purchase of an annuity prior to the closing of the reverse mortgage or before the expiration of the right of the borrower to rescind the reverse mortgage agreement.

Potential reverse mortgage borrowers in states other than California should follow this principal as well and strive keep the reversemortgage and annuity purchase decisions separate from one another.

Unless you are very wealthy, you probably carry insurance for things like auto accidents, house fire, and medical claims – even if you’re fortunate enough to never have filed a claim. Most people value the security and protection that insurance provides in an uncertain world and consider the cost a necessary living expense.

Yet, when it comes to retirement planning a much different attitude seems to emerge. For example, when faced with a decision as to whether to take a fixed monthly pension guaranteed for life or a lump-sum cash payment to manage themselves, a majority opt for the lump-sum. According to Institutional Investor, when employees retire or change jobs, only about five percent select a guaranteed annuity option.

Similarly, reverse mortgages were founded largely on the notion of providing a lifetime income stream for “house rich-cash poor” seniors. Yet the most popular payment option under HUD’s Home Equity Conversion Mortgage (HECM) program isn’t the federally-guaranteed “tenure” (fixed for life) option, but rather the line of credit under which borrowers can draw funds according to any schedule they choose.

To be sure, there are good arguments against choosing fixed payments:

But when it comes to the most important consideration of all – how long you expect to live – most of us aren’t very astute. According to the Society of Actuaries:

A large majority of both retirees and pre-retirees underestimate life expectancies. 61 percent of pre-retirees underestimate and 67 percent of retirees underestimate life spans. One consequence is that they believe they are accurately planning for life expectancy, but in fact are underestimating. While four in 10 think they�re estimating accurately, the reality is that over 50% of them are actually predicting they�ll live shorter than average lifespan, while only three in 10 believe they may live longer than average.

In another study, conducted in May 2003 by the Met Life Mature Market Institute, it was found that most people misunderstood life expectancy statistics and incorrectly thought inflation would be the greatest financial risk faced in retirement:

People are living a significant number of years past the typical retirement age of 65, thus increasing the time horizon over which their savings must last. Just 4 in 10 (37%) respondents believe that an individual who reaches age 65 has a 50% chance to live beyond life expectancy of age 85. They clearly do not understand the concept of life expectancy being an average, with half the population living beyond that age and half never reaching that age. Less than 2 in 10 (16%) of respondents believe there is a 25% chance that one or both members of a 65 year old couple can live to age 97. Lastly, 8 in 10 incorrectly answered that one or both of these members had a 10% chance or no chance to live to age 97. Only 14% of respondents knew that there are 82,000 centenarians in the U.S.– people living to age 100.

Not only do respondents underestimate longevity, they do not view it as a financial risk. That is, just 2 of 10 (23%) respondents understand that longevity is the greatest financial risk facing retirees. Inflation is a very significant financial risk, selected by 41% of respondents, but it is important to note that longevity risk is exacerbated by inflation risk.

Is flexibility truly that important? Is it worth the extra risk, work and anxiety, or would retirees be better served putting such matters on auto-pilot and focusing instead on managing expenses to stay within a budget? There are no right or wrong answers, but reading the comments from the Society of Actuaries and the Met Life study should give anyone weighing this decision reason to pause.