Fulton Financial Consultants, Inc.

A wonderfully inspiring Lady in Langley triggers Case Study Page with Q&A.

Sometimes when I get up in the morning after an evening appointment I feel exhausted and like I am ready to retire.  This morning was a pleasant exception. Last night I went to dinner with a prospective client for a reverse mortgage, it was our second meeting. She had studied all the material I had left with her and had a list of questions for me. These two meetings were about 9 days apart. I found our meeting wonderfully inspiring and found her questions amazing. I woke up this morning and decided to start my long overdue “Case Studies with Q&A’s” section of my website. In my studies as a financial planner I have found “Case Studies” and Q&A are great way to learn. One small world feeling that came out of this was after our first meeting she mailed me and article in “The Times” that quoted the position of on Reverse Mortgage of the “American College of Financial Planning”.  She was surprised to learn that the was the college were I earned my professional education (two professional designations) and a standing member of 31 years in The Society of FSP (Financial Service Professionals) where we learn using “case studies” so this is my first attempt at this. I was glad to learn how supportive the American College was.

My interviews with protective clients for reverse mortgages always start off with the cart before the horse.

During my rather long career, when people meet with me as a financial planner the first meeting is limited to fact finding about the client. This is where and when I gather all the facts about the client’s assets, liabilities, goals, objectives and where the biggest concerns are. But when a client calls me directly from my advertising about reverse mortgages our meeting starts off with a generic presentation about the FHA HECM (Reverse Mortgage). We talk about the solutions my product the Reverse Mortgage has provided for other clients, while I only have a vague idea if they will be a fit or not. This is always very interesting to me, to observe as my sessions with the clients continue eventually I collect indirectly most of the data of my traditional fact finding in general terms. Then I keep fine tuning the product configuration so to speak to meet that specific borrower/homeowner’s needs. By the time the transaction closes I have it complete. I always feel the client would be well served to share the information upfront but that was not what I was initially invited for. It all works out in the end but sometimes before closing I end up totally reconfiguring what I show on the first interview.

Client Profile from data gathered to date of Langley Lady (so far).

So for privacy protection, I will refer to her as, “Langley Lady” she is sixty nine years old and in good health. She is still working, about 29 hours a week (most weeks) and has so far been able to retain (although downward pressure on it) a little short of $200,000.00 in her Traditional IRA which was a rollover from a 401(K) associated with professional career. The nice little nest egg is in addition to her magnificent home (with a live-able downstairs), a world class view over the water from a modest altitude, I could hit a golf ball into the water from her living room carpet, if not for her picture window. Her home will likely appraise (or could sell) for about $599,000.00. She currently has a normal first and second mortgage totally about $301,000.00. The “demand” on her budget for the principal and interest portion of the mortgage payments is significant in relation to her employment income. That income is very much needed to preserve the nest egg. I do not see this current scenario that is sustainable situation as she ages. Paying one payment at a time the old fashion way she will be somewhere around 95 years old before her has budget relief alone. In other words before we can working on increasing the nest egg.

When doing hundreds of financial plans the client almost always goal set and calculated for funding needed to allow the extinguishing of their mortgages on their home by age 65. This was because most clients had “back then” a goal to have their income in retirement come from earning on their nest egg whereby implementing a plan design component called “Capital Retention”. The means to generate the income for monthly needs with interest income and from dividends, never digging into the principal.  Doing made sense because, the amount of capital needed to fund retirement was always less if the budget did not have the “demand” of needing to pay a P&I mortgage payment on our home. Oh, by the way the word, “demand” was her term to explain it. I will use that excellent wording from this point forth. (I am careful to say P&I mortgage payment not PITI mortgage payment because you till have to pay TI (Taxes and Insurance) after closing on your reverse mortgage. 

Aging in Place? A Term used to describe a person or couple living in a residence of their choice for as long as they are able.

Next we discussed the option of “Aging in Place” and determined that was the best solution. We agreed that home ownership offers a great advantage physically, financially and emotionally, compared to those who have to rent.

While the question and concerns are all very similar for seniors the answers and solutions vary widely.

These are the questions and answers which surfaced as we reviewed and discussed  the options of how to provide housing for the future (In normal type) and underlined.

The discussions and answers are in italicized type.

Should I sell this home and put my net equity in the bank and use it to pay for rent for the rest of my life. (so no home ownership and no more Mortgages of any kind.)

This is of course and option. Let us take a quick look at the numbers.

Listing price:     $599,000.00

Net Proceeds:    539,000.00  Which reflects 10% of asset for seller closing cost, plus other.

Less mortgage:-301,000.00

Net proceeds:   $238,000.00 to use to put in the bank and earn interest and use the money to pay rent.

So there are a few questions here, first how much would I need to pay for my rent. Could we be so lucky to have the earnings on the money keep up with the rate of inflation associated with the unknown escalating rent increases from the landlord? (Not likely). The if the rent per month was $1,900.00 then her money allocated for house would run out in ten years, in this case to age 79. That is six to seven years shorter than her life expectancy. That is based on the year she was born on the life expectancy chart on the lender’s FHA related proposal. While avoiding capital risk it is not likely the earnings on the account would keep up with the rent increases do to inflation. She could easily live longer than what average statistics indicate on a chart and I have never done any planning on such unsound footing as that.

Can I make this home work “as is” for me to age in place?  Or do I need to modify my home to make it work for the future? What are the modifications and remodeling I need to make and how will I pay for them.

We discussed main need would be to move the washer and dryer upstairs to the main floor and illuminate the need to walk downstairs. But there is not area for it, currently. We talked about extending the bathroom upstairs to include a small utility room area to hold them. The cost for this modification and remodeling including the permit is not likely to exceed $22,000.00. These funds could be disbursed at closing of escrow from the Reverse Mortgage.

So since we just opened the discussion of introducing the reverse mortgage as the next option, let us explore that now. Upon closing in escrow her remaining equity reserve in the home would be $253,976.00 as show on the pie diagram of my proposal. This is greater than the net proceeds that she would receive if she sold the home, that would be available as show above to pay rent with or show below to go out and purchase a less expensive home. One of the main reasons for this is be the closing costs to close on the Reverse Mortgage that comes out of equity is far less than the closing costs that comes out of equity to sell the home to a third party. I started observing Reverse Mortgages for years (as a financial planner) before I entered the industry and in my personal opinion as a laymen they were no different as any other complex financial instrument in their evolution. They started out as a gimmick and finally emerged into a technique and then were accepted by the regulators and public and then got tuned up to be a valid solution by the industry. My personal never ending take on the technique is that you covert your home equity to a “financial Resource bucket” and allocate it, commit it, not to pay for boats, cars and vacations but to pay for home ownership for you. First let’s review what I call the intrinsic cost of home ownership. If you pay cash for a house like some to these examples you not only pay the $238,000.00 or what ever in one lump sum but also loose the economic benefit of that money over the time now that that money is tied up. Some call this opportunity cost on capital, and at a 5.1% investment return assumption would be over a $1000.00 per month. So that is not free. As American’s we are all trained to thing of our home equity as precious, and it is, but having it tied up is not eliminating a costs. Fact: The elimination of opportunity is costs. If you sell your home to “convert” the equity to a “financial Resource bucket” in the nature of a bank account, to pay rent. Then ask your self who will receive the future financial appreciation in value of your home if you sell it to get that money? Well the purchaser, the new owner, not you! That is because you are no longer the owner. Over a period of time that property could go up substantially, to put it in prospective another $238,000, perhaps. If you eliminate that opportunity by not being the receiver of your home’s future appreciation, that would be a cost to you. Plus you could expose yourself to rent increases. If you keep the property and use the Reverse Mortgage the converted “Home equity Resource bucket” will enjoy as a resource this potential gain together with the allocation and commitment of your current, equity, offers a real opportunity. Then as we have talked about if those numbers are not a success story the FHA insurance offer indemnification for that.

I think I am getting a little too esoteric so I am going to stop that dialog.

This is of course and option. Let us take a quick look at the numbers.

Listing price:   $599,000.00

Net Proceeds:    539,000.00  Which reflect 10% of asset for seller closing cost, plus.

Less mortgage:-301,000.00

Net proceeds:   $238,000.00  to use to purchase a home including, some improvements.  

Should I sell this home and put only 50% of my net equity as a down payment and use a reverse mortgage to pay for the second half. This would increase my nest egg by $119,000.00 which could be used to produce income.

Should I sell this home and use 50% of the proceeds to sale proceeds for a down payment on that same less expensive home of $238,000.00 and pay for the balance using a Reverse Mortgage. This also would extinguish the demand on my budget to pay a P&I payment amount and also put an equal amount of money in my nest egg. This would enhance my capital base and be used to produce income.

This is of course and option. Let us take a quick look at the numbers.

Listing price:   $599,000.00

Net Proceeds:    539,000.00  Which reflect 10% of asset for seller closing cost, plus.

Less mortgage:-301,000.00

Net proceeds:   $238,000.00  to use to purchase a home including, some improvements.  

Purchase price            $238,000.00

Less down payment:  - 119,000.00

Balance to pay:             119,000.00 using a reverse mortgage.

Increase in nest egg:  $119,000.00

Prior nest egg:             198,000.00

New nest egg:              317,000.00

Should I sell this home and put 100% of my net equity as a down payment on home which is worth $476,000. (that I would enjoy that more than a 238K home) and use a reverse mortgage to pay for the second half. This would will not increase my nest egg but I would not have a house payment

Yes I could sell this home and use 100% of the proceeds to sale proceeds for a down payment on home worth $476,000.00 and pay for the balance using a Reverse Mortgage. This also would extinguish the demand on my budget to pay a P&I payment amount but not put any new money in my nest egg.

This is of course and option. Let us take a quick look at the numbers.

Listing price:   $599,000.00

Net Proceeds:    539,000.00  Which reflect 10% of asset for seller closing cost, plus.

Less mortgage:-301,000.00

Net proceeds:   $238,000.00  to use to purchase a home including, some improvements.  

Purchase price            $476,000.00

Less down payment:  - 238,000.00

Balance to pay:            238,000.00 using a reverse mortgage.

Increase in nest egg:       $000.00

Prior nest egg:           198,000.00

New nest egg:            198,000.00     "No Change."

Does having a Reverse Mortgage cause a reduction in home equity?

As I said above she was pleasantly surprised that when one gets a reverse mortgage they still own their equity and they are still vested in the home’s future financial appreciation. The 92 page Pre-HECM Counseling educational proposal I left behind with her included a projection of that future home equity growth and or depletion. This is found on the document called, “Amortization Schedule – Annual Projections”.   The operative word was “projections” because is starts off with an assumption of value, in this case, as I said above $599,000.00 which I feel is super conservative but I rather be that way. This in part for the 4% “Expected Appreciation” factor (which often I feel is high) as an assumption on the property is another variable which influences the outcome that equity that the software illustrates for us. The next is the interest rate on the loan affects the out come. So in this case as I said above when the transaction closes after the closing costs and the UP Front MIP to FHA is paid, and the current first mortgage is extinguished she will have equity reserves still in the property of $253,976.00 and then base on the assumptions indicated here after ten years, her equity will have grown to $378,212.00.  When she saw this she asked for another Amortization Schedule run projecting only 2.5% appreciation on the home that illustrated the equity would have grown to only $258,316.00 and if you look further down the road by the 12th year at age 81 the equity is projected to have shrunk down to $252,891.00, a deduction of over a thousand dollars, and over future years this reduction in home equity, in itself, will be more substantial as the years progress. There are other variable that could come into play that will cause addition equity erosion. But, that is not the whole picture, meaning that does not mean that you have a lower financial net worth because over time your home equity is reduced. That depends on you and I will get into that below.

Why do I always here that having a Reverse Mortgage can increase my financial net worth even though my home equity my actually go down in future years?

As I have shared my clients always feel relived when they see the Amortization Schedule generally projects having their equity increasing for the first 13 years or more. In this case extinguishing her two current mortgages totaling $301,000.00 does take a toll on that, because that amount is so high. So this is a great case study. The whole financial picture needs to be looked at to see the potential for increased financial net worth and sometimes takes a “reversal” of thinking to do that. To say the least it is counter-intuitive, and for her it starts with, “it depends on what she does monthly with the $1,279.00 she use to send to the mortgage companies each month. Currently when she sends that payment in about $448.00 dollars goes to equity and builds the non liquid home equity asset, which is like building a forced savings. You may have noticed “forced” was the operative word. This provides built in motivation to pay that in because if you do not it triggers the process of foreclosure! (This does not seem like a good place to be at age 69). After the reverse mortgage closes and the requirement to pay that payment is gone, to have the discipline to voluntarily put that “full” $1,279.00 under the mattress each and every month, is yet to be seen. But, if you do then the “full” $1,279.00 shows up under your mattress and in a year’s time that adds up to $15,348.00 and in two years to $30,696.00. So in the short term cash-flow picture that generates in 30 days $831.00 more liquidity to meet other needs! Oh, wait, the $448.00 was not liquid at all! Plus you are not scheduled to be able to access that until you sell your home.

The power of redirecting your new found freed up cash flow into a more productive account.

I hope I did not seem too old school to imply that some would make deposits under their mattress. Ha during the big Y2K scare almost everyone I know had a thousand or two someplace like that.

Seriously I used the place to deposit the cash flow freed up in a place which had the same exact investment or interest rate return as the place that her current $448.00 amount gets deposit now. Again, as I shared above, the amount of the monthly P&I mortgage payment was $1,279.00 and that the principal component of $448.00 goes into a forced savings, specifically in her home equity asset account, where the investment return is the same as that of what you get when you put your money under your mattress.

Ha, as I am typing this I hear words of my father, a penny saved is a penny earned, so son you are wrong. I hear him saying, “When you pay that in on the mortgage you are not any longer renting that portion of the money, interest is rent on money, if you don’t pay rent on it you have a savings, if you put it under a mattress you have not savings and no gain”.

Serious, what he means is if the interest rate on the mortgage is 3.75% and I pay it down by $448.00 over the next 365 days I will make a profit of $16.83. But that is all I can earn in indirect profit. This profit is not available in an emergency to protect the home owner nor there to deal with something threatening to homeownership. Let me finish my comparison on this before I explained my thoughts. If I but the $448.00 in to an account which earns a return of 3.75% I have actual direct earnings of $16.83 that I can access in a pinch. There is a potential for higher productivity than this example of 3.75%. That $30,696.00 under the mattress does not have to stay under the mattress. I feel a homeowner with this extra accessible $30,696.00 in the bank, may be a lot more empowered to cope with things that could come up to deal with while owning property than a homeowner who could only look at. What could come up for you could be life and death situations as you age in place. More capital is needed and this is how to get it.

We have risk and perils headed our way, some we can insure against, others just take capital, and some we can’t do anything about.

The next sections are going to review what these risks are. To see how we can best shield ourselves against them, and have a strategy where we can better manage them, and insure against them. Since we are really working with a finite about of resources, when it come to the capital needed part, this is really about managing the buckets properly. These are the “Financial Resource Buckets” which I talked about above. Like managing any portfolio, proper diversification needs to be done. But here I am referring to the type and nature of buckets not the content of the buckets as with investment diversification.

If you thought that purchasing a home was the biggest financial decision you will ever make, then you were wrong. It is how to implement a plan to protect you from these risks.

The biggest financial decision you will ever make is what we are discussing here. If you violate the principle of proper diversification of buckets by putting all your eggs in the wrong bucket you are setting yourself up for guaranteed disappointment a financial hardship in the future. Next failure to allocate resources in the proper buckets also leads to failure. Moderation is a key thing in successful out comes with most subjects including this. We discussed we all were born to want to save up equity in our home, because it feels good and to think about other options is foreign to us. Most of us want to be moving forward accumulating as long as we are able to be productive. In this case let’s look at the resources of $1,279.00 per month coming from a portion of the wages from employment. Currently these are being sent to the mortgage company seeking a credit of equity into the “home equity financial resource bucket” which builds our net worth, but that bucket currently has a balance of just over a quarter of a million dollars already in it. This is more than the $200,000.00 IRA. Consider it is time to suspend the building of that account bucket and open the next one, the next bucket.  I will call that the “side fund” bucket. The purpose of this “Side Fund” bucket is multifold. First, you are still moving forward building your reserves as explained above not too much different that making deposits into your “Home equity financial resource bucket” but the nature of this new bucket is it can protect you from risk. You will just have to add to two buckets together to know how you are doing. These risks are outlined below.

Inflation Risk.

The inflation one, was easy to understand when we were younger years before retirement when we set down and said, “Ok how much do I what for a monthly income at retirement?” The answer was more of a formula that a simple answer. The first part was writing down, the monthly income needed in what we called, “today’s dollars” but back then. Then we established our value system’s belief on what the rate of inflation would be a projection and then we saw what that would need to be out there in the future. Well that future is now, and you can see that is a big number compared to that initial answer before we adjust it for inflation. Even though we are here, now in the future, this is not a reason to disregard what we did in that step of our planning for our future from this point on, over the next 10 – 15 years.

When Inflation, causes “your outgo to exceed your income your upkeep with be your downfall”!