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EPISODE #772
The Problem With Being House Rich
[A Wealth of Common Sense] “There’s a problem with having your wealth so concentrated in your home.”
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[KBTX News] Communication breakdown leads to reverse mortgage foreclosure
   
1 Comment
For those who believe that a reverse mortgage produces diversification and thus less loss due to a natural disaster, it is time to take another look. Let us say the home was appraised at $400,000 and the property had no liens before a HECM was closed. Let us say that the principal limit was $140,000, all mandatory obligations totaled $18,000, and the borrower is taking the maximum Lump Sum available from the HECM at closing. A few months later a flood went through the area wiping out most of the homes of the neighbors of this borrower, home values of the homes that remained fell by 40% and the appraised value was still the best value of the home just before the flood.
No matter how you cut it, the loss on this home is $160,000. With the HECM, the net equity is down from $316,000 to $156,000. If the borrower had not obtained the HECM, net equity would be $240,000. So as a percentage, home equity fell 50,6% with a HECM but only 40% if the borrower had not obtained the HECM. Is this a fair comparison? Yet sometimes we give the impression that diversification with a HECM is always a good thing but sometimes it is questionable at best. Then look at the cost of getting just $66,000 in net proceeds. Dividing $18,000 by $66,000 is 27.3%. I know that many of you will say it is 4.5% but the borrower cannot borrower on the entire Maximum Claim Amount. In many cases the borrower does not know how much of the line of credit at closing he will use. All we know are the facts before us.
Are HECMs always good deals for consumers? If the cost of funds is the only measure of value we have then probably not. This is why it is so important to understand the value of cash flow (not just profit and loss). Know the reasons why cash reserves are so important in financial planning.