The Independent Investor: Home Equity Can Pay for Long-Term Care
A home equity conversion mortgage (HECM) might simply be a fancy term for a reverse mortgage, but there are an increasing number of advisers and planners who are using them for an entirely different strategic planning purpose.
If you ask most couples in their 60s and beyond what is one of the greatest fears for their future, I'm betting that going bankrupt and/or losing their home and life savings as a result of nursing home bills would be right up there near the top.
We all have horror stories to tell of how one or both spouses needed to go into a nursing home and the costs drained all their assets and then some. Before they could apply for Medicaid, they had to go through everything they own — their home, their retirement and savings accounts — all gone. Only then could they qualify for government assistance, which usually means and ending up on a Medicaid waiting list for a remote, tiny room in a facility for the remainder of their lives.
That, my dear reader, is not the kind of "living the dream" Americans have in mind when they think of their future retirement years. Now, of course, the knee-jerk answer to this ever-present nightmare is long-term care insurance Any financial planner worth their salt will tell the average consumer to buy insurance, but there is lots of downside in following that avenue.
Let's take a 65-year-old couple shopping around for this insurance. For the husband, it will probably cost him double what it will cost his wife: A premium of $4,543.76, while the wife pays $2,825.97. That comes to $7,369.73 per year for the couple. And that is only if their health qualifies them for insurance in the first place. These are not fictitious numbers, but taken from a recent Cross Insurance estimate for these 65-year-old sample customers.
In exchange, you get three years of coverage, with a $5,000 monthly benefit (up to $180,000 total) in home care benefits. You will then have to re-new the policy every three years (most likely at higher premiums), regardless of whether or not you used the coverage. For a retired couple watching their finances, living off Social Security and, hopefully, some retirement savings, that's a fairly high expense. In addition, there are many facilities that charge far more than $5,000 a month for the care they give.
However, over the past few years, a number of financial planners have discovered a way to tap into a retiree's home equity in the event that the worst happens and one or the other of you needs outside care. In its simplest form, a couple (of which at least one must be 62 years of age or older), can take out a HECM, or what amounts to a reverse mortgage. But instead of receiving a standard monthly payment, you elect not to take these distributions until the day you need the money to pay for outside nursing care.
Let's take an example where you own your own home, debt-free, worth $500,000. The mortgage company does an appraisal and determines they will loan you half of the amount in an HECM. Like any mortgage, you will be charged fees (origination fees, third party fees, etc.) which comes to about $17,000 or about 7-8 percent of the loan. Like any mortgage, you are still responsible for paying the taxes on the home while continuing to maintain the dwelling, etc.
Those payments you would normally receive from a traditional reverse mortgage are, instead, accumulated in your account at the mortgage company year after year. Think of them as a credit line, which grows and grows. Every year they accumulate, you are paid a half percentage point per annum above the yearly London Inter-Bank Offered Rate (LIBOR interest rate). Currently, LIBOR is trading at about 4.5 percent, plus the half point that you receive above that equates to about 5 percent. These payments to your account accumulate at this risk-free rate until you use them.
Better still, the underlying worth of your house can go up or down but has no impact on your future payments. The primary risk you take is that LIBOR fluctuates, causing the payments you receive to rise or fall over time.
The payments keep working for you until such a time you need them. At some point, the inevitable may occur. One or both spouses needs some form of assisted living. In that case, you simply direct the mortgage company to begin paying monthly sums. If you want, you could request the reverse mortgage payments correspond with the monthly expense of the nursing home. Best of all, these payments are tax-free.
As long as one spouse remains in the home, the house is still yours until the spouse dies or has not lived in the property for the last 12 months. At that point, the house reverts to the mortgage company. If, in the meantime, you still have equity in your home, your beneficiaries receive the remaining proceeds.
But what if you never need to go into a nursing home? Conceivably, the credit line you have accumulated can grow until it exceeds the value of your home. If so, you simply call the company and ask them to cut a check for part or all of your credit line. The point is that the HECM is your long-term care insurance, but it pays you rather than the reverse. Your spouse keeps the house, the Social Security payments, the retirement savings, etc. just like before.
In my next column, we will examine other uses of a HECM and dig into the details of the long-term care concept. Stay tuned.
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The Independent Investor: Reverse Mortgages
Some Baby Boomers have found themselves financially between a rock and a hard place. Rising costs, insufficient retirement savings and, in some cases, health issues, have forced seniors to consider taking out a reverse mortgage on the only asset they own. Is it a good idea?
For those who don't know, a reverse mortgage is a loan that uses a primary residential dwelling as collateral. It provides an option to generate cash by borrowing money against their home equity. Funds can be drawn as a fixed monthly payment, or a line of credit.
In order to participate, at least one owner must be over 62 years old. The bank or financial entity figures out what the house is worth at the time of the loan and lends the borrower a percentage of that number. As an example, if the market price on the home is $350,000, the bank or mortgage lender may front you $275,000.
The borrower then receives a payment (usually monthly) until the amount of equity (in this case, $275,000) in the loan is gone. Unlike a traditional mortgage, however, the amount a borrower owes on a reverse mortgage increases over time. No repayments are required during the borrower's lifetime. Payment is only due when the homeowners die or are no longer living in the property (over the past 12 months).
Over one million reverse mortgages or Home Equity Conversion Mortgages (HECM) have been sold since the government program started back in 1990. The program is run by HUD and over 90 percent of these mortgages are insured by the Federal Housing Administration (FHA). One important reason reverse mortgage are sought after, according to government statistics, is that one-third of U.S. households have nothing saved, while the remaining two-thirds have less than $75,000 in retirement funds. But the program has had its fair share of controversy.
Reverse mortgage scammers abound. Over the years there have been several scandals, including one where more than $1 million of reverse mortgage proceeds from seniors was stolen by a Florida title insurance company. The Consumer Finance Protection Bureau fined three companies a total of $790,000 a few years back for alleged false claims. It is a market where the buyer must beware and therefore borrowers should seek out and do business with the most reputable firms.
One important requirement of taking out a reverse mortgage is the borrower's responsibility of continuing to pay property taxes and maintain the condition of the home. There have been many instances of seniors who were forced into foreclosure prematurely for failing to satisfy one or both of these conditions. Unscrupulous marketers conveniently neglected to inform them of this fact.
The pros of reverse mortgages are fairly obvious. If you are one of the elderly, like my widowed mother-in-law, who was left with little to nothing by her spouse, a reverse mortgage may be your only option to make ends meet. Of course, she could have sold her home, but that is something the majority of seniors are loathed to do. They want to age in place, especially after the loss of their loved one.
She had no income outside of Social Security, so she could not refinance her home. It is true that her heirs (two adult sons and a daughter) would need to repay the loan in order to inherit her home, but two out of the three siblings live elsewhere and have no interest in the house. The reverse mortgage payments are also tax-free, which means a lot of savings when you are on a fixed income.
If, on the other hand, you are retired, but have sufficient income to pay your bills, or are willing to sell your home, either to down-size or to tap into the equity of your house, then reverse mortgages don't make a lot of sense. However, for many of us facing the unknown future of advanced age, the option of taking out a reverse mortgage on what, for most, is our largest asset as a last resort, may be comforting.
There is one caveat, though. If you are contemplating a reverse mortgage and you own a condominium, you are out of luck, unless that condo is FHA-insured. Few, if any condos, in my town, anyway, have ever applied for FHA approval, which is both short-sighted and a major oversite by this region's developers.
In my next column, I examine another type of reverse mortgage that could be a big help in dealing with the one nightmare of all elderly Americans. The fear that without much, if any, long-term care insurance, seniors will end up living in some squalid Medicaid-approved nursing home, depleted of all their assets, while their homeless spouse bags groceries at the local supermarket to survive.
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The Independent Investor: Why FHA Loans Are so Popular
Federal Housing Authority Loans have long been one of the most popular types of mortgage loans available. Roughly 20 percent of all mortgage applicants will choose an FHA loan because it makes total economic sense to do so. And the older you are, the more important having an FHA approved dwelling becomes.
To many, that may appear to contradict your understanding of the FHA loan market. Most believe it is a program to assist younger folks, who need a hand to purchase their first home. You wouldn't be far wrong from a historical perspective, but times have changed.
The FHA loan was originally designed during the Depression years to help home buyers, (usually first-time applicants), with low credit scores and a small bank account, to afford a home. But the FHA doesn't make the loan; the bank does. The Federal Housing Administration, however, guarantees the loan, and as such, provides mortgage lenders an added degree of confidence and security in lending to the prospective home buyer. If the borrower defaults on the loan, the FHA will reimburse the lender the amount due.
Some of the benefits to the borrower include lenient credit scores, much lower minimum down payments (as little as 3.5 percent down), and lower mortgage rates, usually 0.10 percent-0.15 percent lower than the average rates on conventional loans.
The Veterans Administration's Home Loan Program is also available to qualified vets and works like its FHA brethren, guaranteeing the lender a portion of the loan if the vet defaults. An added benefit is that there is usually no minimum down payment required, and much lower credit scores, interest rates, and income requirements than even the FHA loan.
While many youngsters are taking advantage of these government resources, an increasing number of elderly and retirees are seeking out these same benefits, but for entirely different reasons.
As Baby Boomers become empty nesters and then realize they no longer want or can afford the expense, upkeep, and taxes on their original homestead, they are seeking out a more modest and affordable dwelling, either in their local neighborhood or in some more exotic (or warmer) locale. It is called "down-sizing," a popular trend among Boomers that has been gathering steam in this country for decades.
Many times, a condo is the dwelling of choice for these new home buyers. As a result, the number of condos throughout the United States continues to grow. Since most retirees have more than enough money to purchase a condo with the proceeds of their larger home, FHA or VA loans have not been a factor in their purchase until now.
However, for many retirees, cutting expenses is one of the central reasons for downsizing. They find making ends meet is becoming increasingly difficult in today's environment. Social Security benefits, low interest rate returns on fixed income investments, and the rising cost of health care and other services are forcing more of the elderly to pinch pennies. Unfortunately, even downsizing is not enough.
More and more seniors are forced to turn to using their dwelling as an asset of last resort. The use of reverse mortgages to make ends meet is becoming increasingly popular. And here is where the rubber meets the road when it comes to an FHA loan. If your house or your condo is not FHA insured, you do not qualify for a reverse mortgage or a home equity conversion mortgage.
In my next column, I will explain how the failure to qualify your dwelling as an FHA-insured home/condo today can prevent you from leveraging your greatest asset when you need it the most.
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The Independent Investor: The Suburban Dilemma
Over the last decade, the percentage of Baby Boomers, those aged 65 to 74, living in the suburbs increased by almost 50 percent. Over the next 20 years, that age group will double in size, and by 2040, 1 in every 5 Americans will be age 85 or older. The majority of them will continue to live in the suburbs.
Older adults, it appears, move less frequently than any other age group. Over the last 10 years, only 6 percent of persons over 65 years of age moved, according to AARP, compared to 17 percent of those under 65. It's called "aging in place," which is a standing trend that describes how older Americans prefer to stay in their homes and never move. They are attached to their dwelling, their neighborhoods, even to the corner deli (if it still exists).
These adults have lived in their homes for the greater portion of their lives. They are the result of an enormous and long-lasting American socioeconomic trend that began after World War II. It was an age when Americans abandoned the inner city. By the hundreds of thousands per year, they embraced the tract home, the white picket fence, and quarter-acre of lawn or back yard far from the busting crowds of the city.
And as they migrated to greener pastures, shopping malls, and garages, restaurants and other businesses followed, catering to this new suburban lifestyle. The good life in the suburbs became so much a part of our culture that it generated dozens of movies, television shows and novels celebrating this new America.
The problem is that times change. Back in the day, the American family may have selected their suburban dwelling because of a good school system or proximity to the train station or bus depot to their day jobs in the city. But in retirement, those reasons no longer exist.
Neighborhoods have changed as well. What may have been a middle-class subdivision when first purchased may have changed over the years. Many older adults now find themselves living in poor, high-crime neighborhoods. I recall that my neighborhood outside of Philadelphia had been all Irish-German Catholics when I was a kid. Today, it is a haven for Ethiopian refugees and their families. Crime is rampant and the streets, pavements and other infrastructure have fallen on bad times. As a result, older residents do not venture out as much, if at all, virtually becoming prisoners in their own homes.
It is a fact that most suburbs require the use of a car to accomplish the most basic of chores, things like grocery shopping, visiting the doctor, etc. However, it is also true that many of this current generation's women never learned to drive. Now that their husbands have passed, many need to rely on others for mobility. But it is not just women, older adults in general are often required to reduce or stop driving altogether because their eyesight or motor functions have deteriorated to the point where they are a danger to themselves and others on the highway. My suburban mother-in-law, at 90, is facing that problem today.
Suburbia has also fell victim to the internet. Strip and shopping malls are disappearing and with them the services that many older adults need to sustain their suburban lifestyles. As a result, driving distances have lengthened and public transportation is both costly and not easily obtainable.
From an income perspective, while many older suburban dwellers may have paid off their mortgages, they are still faced with large amounts of property taxes, insurance, and utility bills.
The Tax Reform Act of 2018, with its $10,000 cap on state income and property tax deductions, has made that situation much worse for older Americans. As it stands, seven out of 10 of the elderly occupy dwellings that were built at least 30 years ago. Ask any contractor to inspect that house and you will likely be handed a long list of
costly but necessary repairs and upgrades.
As we get older, the very items we will need the most — things like efficient and energy-saving lighting, electrical, air and heating systems, are sorely lacking in the older housing stock.
Enhancements such as handrails or grab bars, entrance/exit ramps, easy-access bathrooms and kitchens, widened doors or hallways and modified sinks, faucets or cabinets become critical, but few of us have the money to install them.
As time goes by and more and more of us age in place, the challenge of suburban living could gradually become more of a nightmare than a case of "living the dream." While there are some strategies, services and support groups that recognize the danger, for the most part, we are on our own. My advice is to plan accordingly when considering your move into retirement.
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The Independent Investor: Long-Term Planning Is Crucial to Caregiving
The family is headed toward a crisis in caring for the elderly. It will impact all of us, so if you have aging parents, don't think you can just close your eyes and hope for the best. You are likely setting yourself up for a world of hurt.
All too often, the adult children of aging parents are blind-sided when presented with the realities of taking care of parents in need. This is usually precipitated by some sort of health crisis. In my own business, I see it time and time again. What follows is pure chaos, anxiety and hard feelings. There is no way to stop the inevitable, because aging and declining health are part of living, so what can you do?
"It is critical that families begin the conversation now to create a long-term care plan. Do not wait for it to become an immediate crisis," says Annalee Kruger, president of Care Right, a Florida-based expert in the area.
The crisis in caregiving has grown exponentially in this country. So much so that Kruger and others like her have been able to establish thriving businesses by providing solutions for families caught up in a care crisis. Her line of work ranges from providing solutions in caring for aging loved ones to acting as a third-party facilitator in family meetings. She coaches family caregivers (who may be dealing with dementia or are just plain burnt out), but her most satisfying work is developing a plan for the future in order to avoid most of the pitfalls ahead.
Unfortunately, crisis management is still a large part of her business. In order to deal with that event, she first needs to understand the actual care needs of your family member going forward. In today's economy, there are innumerable options and choices to make ranging from private sector solutions (if you have the money) to public options. In any given state, there are a myriad of organizations that provide help and assistance to a family in need.
Just knowing the lay of the land in this area requires a great deal of expertise, while matching your family care giving needs with resources available can be a full-time job. Chief among them may be the financial implications of your choices.
If your family is like mine, everyone will have a different opinion of what direction to take and why. Some members of the family may already be at odds from past disagreements. In the best of cases, developing an aging plan that all can agree upon usually requires an outside mediator. As I mentioned in last week's column, many family members today live far apart, and just communicating with a California brother or sister in Maine on an on-going basis is sometimes impossible without help.
As you might imagine, all of the above would be easier on all of us if we didn't wait for an immediate crisis, like Dad falling on his head while cleaning the roof gutters, or Mom's fall in the garage. Logic dictates that we do not wait for an immediate crisis. Your first step is a family meeting.
Krueger suggests a serious meeting should be arranged with the family where three questions are agreed upon: "If mom or dad becomes incapacitated, where will they live? Who will take care of mom or dad? And if they need custodial care, how will the family pay for this care?"
"The answers will form the basis for a long-term care plan," Kruger explains. "If family members disagree regarding the answers, compromise must be made. The entire family must come to a consensus that everyone can live with or risk the disintegration of the family."
As I wrote last week, it is a serious issue that is only going to get worse in the future as more elderly 80-plus family members need help and less and less caregivers (45-64 years old) are around to provide it. Nearly 10 million caregivers are now over 50 years of age. That number is going to explode upward in the next decade. Over 86 percent of these caregivers saw a tremendous impact on their lifestyle. Sixty-four percent of them are funding their parent in some way; accounting for 33 percent of their monthly budget, according to AARP.
If those statistics don't convince you then nothing will. My advice: call that family meeting as soon as possible before it is too late and get some help.
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