The Prosperity Blog

Using a Reverse Mortgage to Stop Foreclosure

Reverse mortgages are touted as a way for elderly retirees to create additional income by
borrowing against the equity in their homes without having to take on another payment.

Instead, the amount borrowed by the homeowner is due only when the home is sold, or the borrower dies. Since the terms of a reverse mortgage are based in part on the age of the borrower (the older the borrower, the more favorable the deal), a reverse mortgage can be a profitable strategy for supplementing one’s retirement lifestyle.

But a December 26, 2007 Wall Street Journal article turned up another use for reverse mortgages: Staving off foreclosures for senior citizens, especially those whipsawed by declining or fixed incomes and rising payments from adjustable rate mortgages. The strategy, used by an increasing number of legal-aid advocates, isn’t suitable for everyone. But in the right circumstances, it can be a financial life-saver. A typical scenario: A senior couple with significant home equity needs cash. Attracted to the favorable terms of an adjustable-rate mortgage (low initial interest rate, minimum payment options), they take on a new mortgage, one they can theoretically afford. Over the next few years, interest rates increase and so do monthly payments. Perhaps because of health issues, increased living costs, or decreased income, the seniors find themselves unable to meet the mortgage obligation, and facing foreclosure. Even though they cannot meet their monthly mortgage obligation, the couple still has substantial equity in their home. With the assistance of a reverse-mortgage expert, the couple uses the remaining equity to negotiate a settlement on the existing mortgage. While they receive no cash out from this arrangement, the settlement eliminates the monthly mortgage payment, and keeps them in their home.

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Knowing the Reasons Not To Do Something

“If you can’t explain it simply, you don’t understand it well enough.”
– Albert Einstein

Ever have this experience trying on new clothes? The “fashion consultant” raves over each new garment, saying things like: “Ooh, I can’t believe how good that looks on you!” or: “Wow, I can’t decide which one I like better!” If you’re like most of us, you probably appreciate the compliments and the personal attention. But there’s also a part of you that knows some of the enthusiasm is because you’re a potential customer. So you take the comments with a grain of salt. But suppose a salesperson said, “You know, that style just doesn’t suit you. I think this one is a better fit.” What would you think?

When it comes to assessing your relationship with the financial professionals that provide input and products for your financial transactions, one of the things you might want to evaluate is how well these people can explain the reasons not to do something, especially the things that they most often recommend or support.

Some examples:
An advisor or financial professional who recommends participation in a qualified retirement plan probably knows all of the benefits of participation – contributions are tax-deductible, it’s taken from your paycheck automatically, there are loan provisions, etc. Since a retirement plan is a basic form of saving, and saving is good, a qualified retirement plan is something that offers a benefit to everyone.

But is there ever a reason not to participate in a qualified plan? What if you are saving for a down payment on a house? What if you have outstanding credit card balances? What if you don’t have six months’ of income set aside in an emergency fund?  Would any of those circumstances change your advisor’s recommendation? From a consumer or client perspective, you want advisors that know both the reasons to participate in a particular strategy or product, and the reasons not to.  Because while most common financial strategies and products have broad application and appeal, they may not be the right fit for your unique situation.

Ideally, competent advisors mention the reasons “not to” as part of their dialog with you. Either it comes in the course of “discovery” conversations about your objectives, current situation, and financial philosophies, or it is part of the education and explanation provided by the advisor when making a recommendation or offering an idea. But if the advisor doesn’t bring up the “not to” reasons, be sure to ask. Getting an answer to the reasons “not to” is like getting a second opinion from the same doctor. It probably won’t change the proposal, but it should give you an even clearer understanding as to why the proposal was made in the first place.

1. Beware the critic.
Getting a second opinion regarding any financial strategy may have merit. But be careful about someone with a narrow perspective or an ax to grind. Some people make a living out of telling people what not to do, and provide very little substance on what to do.

If you’ve had any exposure to the concept of life insurance, you soon pick up on the philosophical conflict between those who advocate term insurance and those who espouse the values of whole life or similar cash value policies. In their little corner of the universe, the divide can be as passionate as that between Yankee and Red Sox fans, or “dog” people vs. “cat” people, and the respective sides can be quite dogmatic about their positions. Historically, both types of policies have a long track record in the marketplace. So regardless of what the critics might say, it appears both types of life insurance have a legitimate place in individual programs. Someone with a one-sided perspective is obviously missing what many consumers find beneficial. It’s the same with the evaluation of qualified retirement plans. Even as they proliferate in the workplace, there’s still a lot of “non-qualified” accumulation going on as well. Again, the ongoing existence of several approaches to accumulation should be an indicator that all of them have some validity.

2. If you aren’t going to do this idea, what are you going to do instead?

Isaac Newton’s first law of mechanical motion is the Law of Inertia: A body in a state of rest tends to remain in such a state, unless acted upon by an external force. The Law of Inertia has application to human psychology as well. Most of us tend to prefer stability and resist change.

When a financial professional challenges you with a new idea, it can be an external force that upsets your status quo. The easiest way to restore your psychological equilibrium is to find a way to dismiss the new idea or strategy. If you’re looking for a reason not to do something simply because you don’t want to – because you’re too busy, or bored, or want to spend the money on something more “fun” – you can always find a reason; a reason to wait, a reason to revisit the issue later, a reason to push the issue aside.

But before you lock in on your reason not to go forward, entertain one more thought: If a trusted advisor gave you the reasons not to, but still believes your situation is one where taking action would be the most beneficial, are you sure you want to blow it off? Go back to the department store example. As you try on several outfits, the fashion consultant steers you away from several lesser choices. But after much review, there’s a moment where the fashion consultant says, “Hey, that’s a perfect fit for you.”  Are you going to ignore that input?

Asking financial professionals for the reasons not to do something is a way to make their input even more valuable to you. But getting better advice and better understanding doesn’t mean much if you don’t act on it.  The purpose of getting the reasons not to do something is to get a better idea of what to do. Don’t let not doing be your undoing.

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