Syndicated Columnist Recommends Cross-Selling Strategy…with a Twist
Just as the reverse mortgage suffered much negative media coverage and hand-wringing from financial pundits, so have annuities. If an annuity sounds familiar to reverse mortgage professionals, it should. Annuities were the financial product most often associated with what many considered a questionable and unethical practice- the cross-selling of financial products investing the proceeds into annuities.Surprisingly, one columnist and economist recommends taking out a traditional mortgage and investing in an annuity.
An annuity is a contractual agreement between an investor and typically an insurance company. A lump sum is invested and then can be ‘annuitized’ or paid out over a period of time, deferred until a later date for full withdrawal, or rolled over into another investment. There are four basic types: immediate, fixed, indexed and variable. An immediate annuity converts a lump sum premium investment into an immediate stream of payments over a specified period of time, usually over one’s lifetime. This is often referred to as a Single Premium Immediate Annuity (SPIA). A fixed annuity guarantees a declared interest rate. The indexed annuity is a variant of the fixed but credits interest based on the percentage growth tied to marked indices such as the S&P500 or the Dow Jones Industrial Average (DJIA). Variable annuities invest funds into mutual funds or other market investments that can be subject to loss of principle in many instances.
Syndicated columnist Laurence Kotlikoff opens his column with the statement, “HUD fails to mention a clear-cut and, to me, far safer way, at least for older people, to tap home equity.” But is Kotlikoff’s ‘way’ truly a safer option? Let’s examine his suggestion more closely.
“HUD fails to mention a clear-cut and, to me, far safer way, at least for older people, to tap home equity. This entails taking out a long-term fixed mortgage on your home and using the proceeds to purchase a fixed annuity payment.
4 Comments
What needs to be considered here is will the borrowers qualify for a equity loan. If they are on a Soc. Sec now and a small pension, they may not qualify for enough. Assume they do, now they have a mortgage payment and sometimes repayment is interest only then going to a fully amortizing which may be difficult to make. In this option , now you have annuity income but a monthly payment to make also. Before being negative toward reverse mortgages do a comparison between both options. The numbers will tell which way to go.
Stephen,
So please do the example so that we can see which way to go in the confines of your assumptions. Talk is cheap.
The real issue is similar to the issues related to wrap around mortgages.
A wrap around mortgage is generated when a home is sold but title is not transferred until the mortgage is paid in full known as a land contract. Rather looking at their dissimilarities, let us focus on their common issues.
In a wrap around (also known as an all inclusive deed of trust), the new lender makes payments to all the existing lien holders having greater priority in foreclosure. The problem for the wrap around lender is to ensure that the cash flow from the new mortgage is sufficient to make the monthly payments required on the existing liens. At the same time, the wrap lender wants some profit so will usually charge a higher interest rate than the average effective interest rate charged by the existing lien holders.
So there are the matters of having 1) sufficient arbitrage and 2) cash flow to cover property charges that may have to be impounded in different periodic payments than the borrower may expect. Also the annuity distributions maybe insufficient to even cover the monthly (or other period) payments of interest and principal.
In many cases today, however, interest earned is less than mortgage interest. Also this is a leveraged transaction adding additional risk to the annuity transaction.
Is it a good idea? In some cases, it might work but in most cases risk may cause a savvy senior to see that the reward is not worth the risk.
I think it would be nice to expand on this example. Just a quick comparison, for a deeper understanding of Annuity vs. Hecm. I can’t believe taking out an annuity with the equity in your home was even mentioned. AS a RM LO we have been told under no circumstance should we ever take a RM’s proceeds and encourage them to do any investments especially an annuity or LTC. What is he saying, let’s skirt what is a big no-no and do it a different way and leave the seniors in a bad way with a monthly payment….NO WAY! This is a bad idea!
B Donner,
The following seems to be your understanding of our ethical standard: “AS a RM LO we have been told under no circumstance should we ever take a RM’s proceeds and encourage them to do any investments especially an annuity or LTC.” (Sic)
First, you should never take proceeds from any HECM (other than your own) for any purpose, period unless you are the lender (not just the originator) or an employee of a servicer and are approved to do so for some specific purpose authorized by appropriate parties. Second, you are a mortgage originator and should not provide financial advising services to a mortgage origination client unless you have a separate agreement addressing the arrangement.
Even when preparing income tax returns or consulting, I have a separate engagement letter covering those services. Then if I also originate, there is also a separate written contract covering that service with the lender and another between the lender and the borrower.
In some cases what the author promotes could well work to the advantage of the senior but for most, this concept is too risky to employ successfully. Therefore, its advisability should be rare.