Thursday, September 3, 2015

Reverse Mortgages Suck: Don't Use a Reverse Mortgage If Other Options Exist

After seeing the option of reverse mortgages being mentioned in the papers too frequently as an option for 'asset rich retirees who are income poor', I just have to put my thoughts out there for those who are investigating reverse mortgage as an option.

Don't take out a reverse mortgage if you can avoid it.

You have probably spent the past twenty to thirty years paying off your mortgage where the first ten to twenty years was all interest payment and barely any principle. Do you really want the amortisation to work against you again in the last decades of your life when you should be enjoying life?

With reverse mortgages, there are no repayments, loan interest is added onto the principal amount borrowed to be paid off when the property is sold. The debt will grow fast. It will be interest debt compounded with interest charged on interest. 

Compound interest works in your favour when you put your savings in the bank. Interest charges compounded year after year will destroy the equity in your home when it's left to accumulate in the typical reverse mortgage structure.

Ever heard of a loan amortisation schedule? I really recommend looking it up if you haven't. 

When someone buys a property and takes out a mortgage, the first few years of payments will be almost all interest and barely any principle. Most people's eyes will glaze over when they read about an amortisation schedule and the break down of interest to principle in a monthly repayment. Let me illustrate with an example:

Scenario: Jack and Jill takes out a mortgage for $300,000. Principle and interest. 30 year term. Interest rate of 5%. 

1.Principal and interest monthly repayments = $1610.46 ; interest=$1250.00, principal=$360.46

2. After 195 months (just over 16 years!) = P+I monthly repayment =$1610.46; interest=$802.88, principal=$807.59. The monthly repayments will now start eroding your loan principal faster and faster from 195 months

3. After 360 months (30 years)= P+I monthly repayment =$1610.46; interest=$6.68, principal=$1603.78. Loan is finally repaid

With a reverse mortgage, you would replay that scenario backwards! Where the 360 month(30th year) redraw from the mortgage of $1610.46 means $1250.00 is the interest charge and you effectively get only $360.46 to spend out of that $1610.46.

But you don't need that much? But you won't be redrawing for that long? It doesn't matter how much or the time frame of the redraw, the amortisation schedule is an eye opener and you are really giving your future, older self a hard time if you take out a reverse mortgage because the interest charge compounded on interest will erode your equity.

You could live to 100 years old and beyond. You could be homeless. I'm not even being dramatic. It's just the way the maths work. So don't take out a reverse mortgage if you have other options or you can avoid it. Just thought I would analyse that for anyone who is trying to do research because it is such a detrimental option but it is being bandied about in the news as an attractive option with no draw backs mentioned or high lighted.

I haven't come across a single article in mainstream news yet that highlights and objectively analyses the pros and cons of reverse mortgages. Only the benefits are discussed. 

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