The Ins and Outs of Reverse Mortgages

Reverse mortgages have been around since 1989, but they are rapidly gaining in popularity. The complexity of reverse mortgages makes it difficult for the average senior to separate myth from reality. Let me help you decide if one is right for you. I believe that the reverse mortgage can work effectively for seniors in the right situation. I’m also concerned that they are being heavily promoted to seniors who shouldn’t be using them. Last week, I explained the ins and outs of interest-only mortgages and how they can be a valuable tool for some seniors. I also warned readers against the option-ARM mortgage. Those articles can be found at www.guardingyourwealth.com. The number of reverse mortgage originations doubled between 2003 and 2004. These numbers may continue to double each year. The media is filled with sales pitches for these mortgages, promising easy money and painless solutions to senior’s financial problems. You must be at least 62-years old to get a reverse mortgage. They are designed to help financially strapped seniors meet their living expenses and to stay in their home. A reverse mortgage allows the homeowner to tap into their home equity without having to make monthly payments. So it can increase the money available for expenses without adding to those expenses. Reverse mortgages allow you to receive money in several ways. The most popular is the equity line of credit. This way you only borrow money as you need it. You can also receive a lump sum or fixed monthly checks for the rest of your life, much like an annuity or pension. You can even receive a combination of these options. The amount you receive depends on your age, the value of your home and even the area in which you live. A reverse mortgage is still a loan, but it’s not paid back until the last mortgage holder dies, your home is sold or it’s left unoccupied for 1 year. If you and your spouse go into a nursing home and don’t occupy the home for 1 year, then the loan becomes due and your house must be sold. You (or your heirs) would receive any money left over after the reverse mortgage is paid. If the house sold for less than the loan amount, the lender would have to eat the loss. Lenders won’t allow you to borrow the full value of your home. Depending on the program and other variables, you may only be able to access 60% of your home equity. It can be far less than that. Fees can be very high and options can vary widely from one provider to the next, so making accurate comparisons between providers can be very difficult. I believe that a reverse mortgage can work well for seniors who have a limited income and wouldn’t otherwise be able to make it without tapping into their home equity. A reverse mortgage can be a low-risk way for seniors to remain in their home for the rest of their lives. That’s why HUD created reverse mortgages in the first place, to help cash-strapped seniors stay out of poverty without losing their homes. A reverse mortgage shouldn’t be used, though, until the money in Certificates of Deposit and other investments is already gone. A reverse mortgage should be the source of last resort. That’s certainly not the message you get from reverse mortgage providers. They show middle class seniors now free to travel or buy that nice new car. Too often, seniors are being enticed into these mortgages by the idea of it being ‘free’ money. It isn’t. If you spend your home equity now on non-essential purchases, you won’t have access to that money later should you really need it. I think a reverse mortgage is wrong for those being tempted to live beyond their means. Even worse is when financial advisors encourage proceeds from a reverse mortgage be used for other investments, such as equity indexed annuities. Be very hesitant if you are approached by a mortgage broker by phone, seminar or mail. Remember, using money from your home isn’t ‘free’ money. Spending it is no different then spending money in a CD or taking your principle out of a mutual fund. Have a financial question? Send me an email and I’ll personally respond, free of charge. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

Are New Mortgages Right For You?

Financial salespeople such as investment advisors and mortgage brokers are recommending ‘new’ types of mortgages for improving cash-flow, freeing up money to invest, and having money to take that dream vacation. Their sales pitches sound so enticing. But here’s what they don’t tell you. In the past, the only decision to make when getting a mortgage was whether you wanted a fixed or adjustable rate. Now, seniors are being pitched interest-only mortgages, option-ARMs and reverse mortgages. It’s easy to become confused and overwhelmed. The result is you can spend thousands of dollars in fees and end up with a mortgage that doesn’t meet your needs. In a traditional mortgage, part of each monthly payment covers interest while the rest goes to pay down the principle amount you borrowed. With each payment you are decreasing the amount you owe and increasing your equity. Interest-only, option-ARMs and reverse mortgages function quite differently from the traditional mortgage. Instead of decreasing the amount you owe, you will most likely be maintaining the same level of debt. In some cases you will actually be increasing the amount you owe—you will be going further into debt with each payment you make! With an interest-only mortgage, you pay the amount of interest due each month for the first 10 years. This is still a 30-year mortgage, but you don’t begin paying down principle until year 11. Since there isn’t any money going to principle, your monthly payments will be less than with a traditional mortgage only during those first 10 years. This can make sense in certain situations—especially for cash-strapped seniors. Since the monthly payment is lower, it will reduce what you take out of your retirement account. That means you won’t have to pay income tax on that retirement money. It can continue to grow tax-deferred. I only recommend this strategy as long as there remains at least 25% home-equity. Also, it’s not a good idea to tap into equity during the refinancing to buy a new car or take a fancy vacation. This isn’t free money. Spending the equity in your home is no different than spending the money you’ve invested in a CD or mutual fund. The option-ARM is being heavily promoted these days—but watch out! They’re sold based on their low introductory interest rate (as low as 1%) and a special low payment. And they give you the ‘option’ of the kind of payment you make each month. You can make the special low payment, you can pay the interest-only, or you can pay principle and interest just like a traditional mortgage. On the surface this sounds good, allowing seniors to increase cash flow or to free-up their home equity so they can invest it in other, ‘better’ investments such as equity-indexed annuities. But don’t do it. People buying this mortgage think they are getting a great deal because of the low interest rate and the low payment. What they don’t realize (and what isn’t properly explained to them) is that each time they make that special low payment they are going further into debt. Think about it. Let’s say you borrow $200,000 and the interest-only payment is $1000 per month. If you instead make a payment of $400 then the $600 in interest you didn’t pay is added to what you owe. So next month the interest due is based on owing $200,600. Do this for a year and you have dramatically increased what you owe. Instead of saving money like you thought, you were actually spending the equity in your home on other things. The low introductory rate only lasts a short time, often just a few months. After that, you can end up paying a higher interest rate than if you went with a traditional mortgage in the first place. The costs of getting an option-ARM are higher as well. These only make sense in a few isolated situations. Most people should stay away from them. Next week I’ll talk about the advantages and disadvantages of reverse mortgages. I will also share stories from my readers that illustrate the shady mortgage-related sales pitches that are now being used. Don’t buy one of these mortgages until then. Have a financial question? Send me an email and I’ll personally respond, free of charge. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

Exchange-Traded Funds Gain In Popularity

Since being introduced in the mid ‘90’s, Exchange-Traded Funds have continued to grow in popularity. Over 60% of money flowing into index fund-type vehicles is going into Exchange-Traded Funds. Should you be using them? Read on to find out. I recently spoke in New York City at a national summit for financial advisors that focused on Exchange-Traded Funds. Over 200 advisors from all over the country attended and learned why the use of exchange-traded funds can give them a competitive advantage and benefit their clients. Whether you are a traditional buy and hold investor, or actively trade to profit from shorter-term opportunities, you should strongly consider their use. Exchange-Traded Funds (ETFs) are designed to mirror a market index. The three most popular stock market indices are the Dow Jones Industrial Average, the S&P 500 and the NASDAQ. The ETFs that mirror these indices are referred to as Diamonds, Spiders and Cubes because their symbols are DIA, SPY and QQQ. Exchange-Traded Funds provide the diversification benefits of a mutual fund with the advantage of being traded like an individual stock. Whereas a mutual fund can only be bought or sold based on that day’s closing price, Exchange-Traded Funds can be bought or sold anytime throughout the trading day. This allows you to more quickly enter or exit the market during the day. With over 172 different ETFs, there is an ETF for practically every index available. In fact, ETFs track nearly twice as many broad-based market indexes as traditional index mutual funds. This creates amazing flexibility in structuring an overall portfolio to the specific needs of any investor. Besides many broad-based ETFs, there are also ones targeting specific sectors of the market. And Exchange-Traded Funds aren’t just for stock-based investments. There are separate ETFs that invest in bonds, real estate, precious metals and other commodities. There are ETFs designed for growth and others designed for income. The internal expenses of most Exchange-Traded Funds are very low. The average actively-managed mutual fund may have internal expenses over 1% per year. The internal expenses of Diamonds, Spiders and Cubes are less than 1/5 of 1% per year. (Since ETFs are purchased like a stock, there is a commission to buy and sell them. The use of a discount broker should minimize this expense.) The majority of exchange-traded funds are not actively managed. In that sense they are very similar to an indexed mutual fund. Recently, though, actively-managed ETFs have been introduced to the market. Expect more and more of these to become available over the next few years. Exchange-traded funds allow an investor to control when the taxes will be paid on an investment, whereas in a traditional mutual fund those decisions are made by someone else. An investor can also sell a stock or mutual fund to generate a tax-deductible loss and then replace that investment with a similar ETF. Moreover, ETFs can be sold-short without having to wait for an ‘uptick’. To short an individual stock you must wait for it to trade higher than its previous trade (referred to as an uptick). As a result, it can be difficult to sell-short when the market is falling. With ETFs, you can easily sell-short in a falling market and thus profit from it. This is one technique that can be effectively used to protect the rest of your non- IRA portfolio. To summarize, ETFs can be used in many ways. They can be used to round out a portfolio. If you have several individual stocks that you don’t want to sell for tax reasons, ETFs can be used to add diversification. ETFs can be sold short so they can also be used to protect the rest of your portfolio in a falling market. Or ETFs can be used to increase specific exposure of an overall portfolio. For instance, you could have international exposure but overweight Japan by buying a broad-based international ETF and a Japan-focused ETF. I use ETFs extensively in my client’s accounts because of their flexibility and low cost. Your portfolio can probably benefit from their use as well. If you would like to learn more about how to use ETFs in your portfolio just let me know. For clear, straightforward, unbiased answers to your financial questions contact me at jeff@guardingyourwealth.com. Mr. Voudrie is a Certified Financial Planner, nationally syndicated newspaper columnist and President of Legacy Planning Group, Inc., a Private Wealth Management Firm in Johnson City, TN. He can be reached toll-free at 1-877-827-1463 or www.guardingyourwealth.com.

Katrina: What’s An Investor To Do?

The devastation caused by Hurricane Katrina has shocked our nation. One reader recently asked me what I thought the short and long-term impact will be on the markets and how he should adjust his portfolio. Read on to find out if you should be making changes. My clients pay me to manage their money. They expect me to take action to protect their hard-earned money from loss. As I woke up Monday morning and became aware of the degree of devastation caused by the hurricane the night before, I had to decide what actions I would take for the tens of millions of dollars I manage. I researched the impact other major hurricanes had on the market. Following Andrew in the early ‘90’s and Ivan last year, the markets had very muted reactions. In both situations the S&P 500 dropped roughly 1% and then quickly rebounded. On the other hand, the markets fell over 10% within days of the terrorist attack on September 11th, 2001. It took the nation and the markets months, if not years, to recover. Would the market impact of Katrina be more like that of previous hurricanes or like the significant decline following the terrorist attack? I judged the market could have an initial negative reaction but would quickly recover and that the money spent rebuilding after the storm would actually cause the market to go up. And that’s exactly what happened. Initially, some investors reacted out of fear and sold their stocks causing the markets to fall. Even then the decline was muted. For the week, the markets actually ended up and on September 6th, the markets were up well over 1%. Here’s why. As devastating as the hurricane was on the lives of those affected, professional investors react based on long-term financial effects. There’s no question that in the short-term oil supplies will be disrupted. Transportation routes are closed and gasoline prices are up. The stock market doesn’t focus on short-term events. The stock market is a leading indicator. That means that stock prices today reflect what investors think companies will be worth 6 months down the road. Obviously, between now and the end of the year, there will be many companies that won’t make as much as they thought they would. That’s understandable and is seen as being an extraordinary event. How will these companies and the markets do after that? Think about what is going to take place over the next year or two. Over 1 million people have been displaced. Many only have the clothes on their backs. Literally hundreds of thousands of homes and businesses have been damaged or destroyed by the storm. It’s the same for roads and bridges, phone and power lines, cell phone towers, trucks, cargo containers, oil rigs and shipping lanes. These people will have to buy clothes. They will have to rebuild their homes or find other places to live. They will have to replace their automobiles. They will have to replace their home furnishings. The commercial infrastructure also has to be replaced or rebuilt. Literally hundreds of billions of dollars will be spent and virtually every sector of our economy will benefit. Financially, the impact of Katrina will cause an economy that had been slowing to expand further. Companies will need more raw materials and employees to meet this demand. Wages may increase. I don’t believe the Federal Reserve will keep interest rates at their current levels. Energy costs are causing general merchandise prices to rise. The demand for goods and services in the wake of Katrina will cause prices to go up even further. As a result, I believe the Federal Reserve will continue to raise the Federal Funds Rate. That means that interest rate will continue to rise. So don’t panic. Don’t react out of fear and make drastic changes to your portfolio or your strategy. If you are an ultra-conservative investor that can’t stomach the gyrations of the stock market, then you should continue to avoid it and invest in things like government-guaranteed Certificates of Deposit. Those who have a portion of their portfolios in the stock market or real-estate should leave them there and possibly even increase their equity exposure. Have a financial question? Send me an email and I’ll personally respond, free of charge. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.