My personal attitude towards reverse mortgages is that they should be thought of as a last resort, by those at or near retirement who are desperate to remain in their homes but lack the funds to do so. With that in mind, I’d like to use today’s post to address the emerging trend of using reverse mortgages to fund investments.

Let’s begin by understanding how this strategy works. Basically, one approved for a reverse mortgage can technically use the proceeds for any purpose, from paying off a current mortgage to buying a new car, from making repairs on a home to paying for a nephew’s college education. A new school of thought holds that it is sensible to take the proceeds and invest them. The reasoning is that such is a form of diversification, by taking capital that was otherwise concentrated in real estate (i.e. one’s home) and allocating it among various other assets.

Contrary to what its advocates would have you believe, the strategy is hardly novel. Mortgage borrowers (sometimes with encouragement from financial planners) have long been using home equity lines of credit and unconventional mortgage products, as means for using their home as collateral to gamble in the stock market.

On the one hand, the credit crisis pretty much obliterated any viability in this strategy. On the other hand, the credit crisis simultaneously proved that keeping all of one’s assets in one’s home was also not the most sensible investment. The important distinction, however, is that a home provides utility (i.e. it can be lived in), whereas 100 shares of Microsoft provide no such utility- only the possibility of appreciation.

Over the long-term, equities have typically outperformed real estate. Based on this logic, some would argue that it’s reasonable to invest more money in the stock market than in your home. All else being equal, this strategy could be defended. Using a reverse mortgage to fund such investments is slightly less defensible.

If your reverse mortgage APR (i.e. the real annual cost of the loan, including all fees, insurance premiums, etc.) is 6% and you are confident you can earn a 9% return by investing in an S&P 500 Index Fund, you just nabbed a 3% return, without doing any work. After accounting for taxes however, your return is probably closer to 2%, which is approximately equal to the long-term rate of inflation. In other words, you gambled with the equity in your home to achieve a real return of 0%. Of course, there are plenty of people who won’t be deterred by this argument, but these are probably the same people that consider BlackJack a type of investment.

What about wealthy people who have money set aside for retirement, and can afford to gamble their home equity in the stock market? For such people, it seems unlikely that they would need a reverse mortgage, since those who can afford to retire comfortably probably have plenty of ziquid assets. It would be equally unsuitable for upper middle class retirees, with just enough in their retirement accounts, to undertake this strategy, in the event that it leads to losses. In the even thet were forced to sell their home, they would find themselves with less equity, after paying back the reverse mortgage.

This leads me to my final criticism, which is that taking equity out of your home does not necessarily protect you from a downturn in the real estate market. For example, let’s pretend that you own your $500,000 home outright. After a real estate market crash, let’s assume that you could only sell your home for $300,000. What if you had taken that $200,000 out of your home to invest in stocks and earned a modest real return of $30,000. After selling your home for $300,000 and paying back the $200,000 reverse mortgage, you are left with $330,000, not much more than you ended up with otherwise.

In the end, you have to ask yourself if you think it’s worthwhile to play roulette with your home. For me, the answer to this question is an unequivocal NO.

One Response to “Reverse Mortgages as Vehicles for Investment”

  1. David Bernstein Says:

    Pretend this:
    My home is valued at 1.5M.
    I apply for an FHA Insured Reverse Mortgage (Line of Credit)
    At my age I qualify for a net amount after all expenses for $400,000.
    I purchase properties that presently are under valued. Lease them with short term leases.
    When home values improve, I sell my investment properties, & repay the Reverse Mortgage. Leaving me with the ability to re-borrow from the line of credit if I choose to do so.

    Why assume only those in need should use the Reverse Mortgage Program.

    I will collect rent, not have to make mortgage payments,and wait for property values to rise.

    For me the answer is creativity.

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