Finance / Mortgage / Retirement: Question (and Answer) of the Day

March 27, 2021

Question of the DayIs an assurance that my financial advisor “does well when I do well” a guarantee that I am being charged fairly?

Answer:  No. Most financial advisors charge by taking a small percentage of the market value of the assets being managed. If you have a portfolio worth $500,000, for example, and the advisor charges ½% per year, the charge would be $2500. If the portfolio value then rises to $800,000, the charge would rise to $4,000. That is the sense in which the advisor does well when the client does well. But note the following caveats:

  • If the portfolio value stays unchanged, the advisor would still make a $2500 fee. In this case, the advisor does OK even though the client has done poorly.
  • The advisor might be charging ½% when another advisor is charging ¼% for the same service. In this case, the advisor is doing well but the client is being over-charged.
  • Advisors generally reduce their rates on larger portfolios, but the break points vary widely. This means that a client paying a competitive rate on a $500,000 portfolio might be over-charged when the portfolio gets to $2 million.

For all of these reasons, I prefer dealing with an advisor who charges a fixed dollar fee for services.

March 23, 2021

Question of the DayAre There Different Types of Credit Line on HECM Reverse Mortgages?

Answer: No, HECM lines of credit differ only in amount. Borrowers with large equity in their homes, for example, can get larger lines than borrowers with less equity. And older borrowers can get larger lines than younger ones.

While there is only one type of HECM credit line, borrowers use them for a variety of different purposes, some of which strengthen borrower retirement plans, and some of which don’t. Uses that strengthen retirement plans include:

  • Holding the line unused as a reserve against the possibility that variability of spendable funds drawn from financial assets may undergo a temporary decline.

  • Holding the line unused as a reserve against the possibility that the borrower will outlive her financial assets. Unused reserves increase over time at a rate equal to the HECM loan rate plus the mortgage insurance premium.

A credit line can also be used to draw cash at closing, which can be used to fix the house, which probably would be useful, or to pay for a gambling junket to Las Vegas, which probably wouldn’t. One of the best uses is to purchase a lifetime annuity. Just make sure that you report the source of the funds used to purchase the annuity as the deposit in which you placed the cash you drew on the HECM credit line.

Some time ago HUD declared that borrowers could only draw half of their line at closing, the remainder a year later. This forces the gambling junky to make 2 trips to Vegas, but it also has the unfortunate effect of forcing the prudent borrower to purchase two annuities.

 

March 15, 2021

Question of the DayWhat are the weaknesses of the private retirement system?

Answer: Here are some of the important ones:

Risk of Running Out: Retirees dependent upon liquidations from a portfolio of
financial assets run the risk of a market decline in asset values, an inflation-based
reduction in their purchasing power, or simply outliving the assets.

Inefficient Markets in Annuities: Retirees attempting to protect themselves
against running out by purchasing an annuity find many advisors anxious for their
business but no easy-to-manage way to shop for the best price. They will find
even more advisors hostile to annuities because the purchase of an annuity reduces
the financial assets on which their fees are based.

Inefficient Markets in HECM Reverse Mortgages: Some homeowners look to
strengthen their retirement by converting some or all of the equity in their homes
into spendable funds. The complexity of HECMs makes it extremely difficult to
find the best option and the best price.

Lack of Integration Among Retirement Tools: The three major components of
a retirement plan – financial asset management, annuities and HECM reverse
mortgages -- are all marketed and delivered as stand-alone programs. Some of the
major consequences are:

  • Major efficiencies and symmetries arising from coordination of important
    features of the components, such as the risk profile of financial assets,
    deferment period on annuities, and the payment option on HECMs, are not
    realized.

  • Options that retirees should have regarding how and when they can draw
    funds without jeopardizing their future, are not provided.

  • The estates of retirees are governed more by chance than by purposeful
    actions by the retiree.

 

March 14, 2021

Question of the DayCan mortgage insurance be cancelled, and if so, how?

Answer: On FHA-insured mortgages, mortgage insurance is no longer cancellable. With private conventional mortgages, borrowers can request termination when the loan balance is paid down to 80% of original property value - the value when the loan was taken out. Termination happens automatically when the ratio hits 78%.

If the loan is owned by Fannie Mae or Freddie Mac, termination is based on current appraised value rather than original value. You can terminate after 2 years if the balance is 75% of appraised value or less, and after 5 years if the ratio is 80% or less.


See Cancelling Private Mortgage Insurance.

 

March 13, 2021

Question of the DayWhat is “reversed” in a reverse mortgage?

Answer: On a HECM reverse mortgage, the differences are substantial.

  • On a standard mortgage, all funds are drawn at the outset of the transaction only. On a reverse mortgage, borrowers can draw funds as a monthly payment for a specified period, or as intermittent draws against a credit line.

  • On a standard mortgage, borrowers must make monthly payments that will pay off the loan balance over a pre-set term. On a reverse mortgage, there is no required monthly payment, and no specified term. The reverse mortgage loan is repaid if the borrower elects to do so, otherwise repayment is not required until the borrower dies or moves out of the house permanently.

  • Reflecting the difference in payment patterns, on a standard mortgage, borrowers build equity over time as they pay down the loan balance. On a reverse mortgage, the borrower’s equity declines over time as the loan balance rises.

See How Do HECM Reverse Mortgages Work?

 

March 12, 2021

Question of the DayHow do seniors with computers protect themselves against medical scams directed to their age-related ailments?

Answer: It is challenging. Seniors should be aware that medical scams follow a predictable pattern, as if they were all tutored by the same marketing guru. They all have:

  • An ailment that is widely distributed, and not of much interest to MDs. Tremors and memory loss are good illustrations.

  • A spokesperson who has the gift of being able to engage the listener.

  • A villain, who the spokesperson and the client will defeat. Big Pharma is a favorite.

  • A hero who is responsible for making the cure available.

  • An engaging story about how the hero discovered the remedy.

Seniors who are victimized by medical scams are not likely to be pushed into poverty, so long as they restrict any purchase to a single transaction. A few weeks ago, I succumbed to a pitch that promised to remedy the tremor in my right hand. I took a few of the pills, then put them aside. It wasn’t a lot of money – I did not sign up for regular deliveries. And I enjoy hearing their pitch. See Internet-Based Medical Scams

 

March 11, 2021

Question of the DayCan a mortgage borrower with enough money to make a sizeable down payment do better by making a small down payment and using the excess to make an extra principal payment in the first month?

Answer: No, the claim is asinine, and the only reason I bother with it is that the claim is being promoted on the internet.

Here is an example of the claim. Assume a property value of $100,000 at 3% for 30 years. In the base case, the borrower makes a 20% down payment of $20,000, which results in total interest over the 30 years of $41,420. In the proposed variant, the down payment is reduced to $5000 and an extra payment of $15,000 is made in month one. Total interest over the 30 years is $31,052 or $10,368 less than in the base case. That is trumpeted as a saving to the borrower.

In fact, it is nothing of the sort. What should matter to a borrower is not total interest but total payments of interest and principal. The variant case calculates the monthly payment on $95,000 rather than on $80,000, which increases the required monthly payment from $337.29 to $400.53. Over the 30 years, total payments with the variant are $22,766 larger than in the base case.

To compound the loss, in the variant case the borrower will have to pay for mortgage insurance for an indeterminant period. While the rules for dropping insurance are anything but clear, insurance premiums will have to be paid for at least 2 years, though 5 years is more likely.

The example given was drawn from a spreadsheet on my web site, available to anyone who wants to check it out. Extra Payments on Monthly Payment Fixed-Rate Mortgages.

 

March 10, 2021

Question of the DayDoes it make sense for a borrower to accept an offer of payment forbearance if they don’t need it?

Answer: No, because forbearance means deferment, not forgiveness. The scheduled payment you don’t make under a forbearance arrangement will have to be made up in the future. There are three kinds of adjustment when the period of deferment ends:

  • Making a larger monthly payment.

  • Retaining the original payment but extending the term.

  • Making a one-time payment sufficient to put the borrower back with the original payment and term.

These are useful options if the alternative is default and foreclosure, but they have no value to a borrower who doesn’t need them for that purpose. See Don’t Confuse Forbearance With Forgiveness.

March 9, 2021

Question of the Day“Which seniors should reject a HECM reverse mortgage, and which should consider one?”

Answer:

Seniors who should say “no”:

  • They have enough spendable funds without it.
  • They want to pass on a debt-free house to their heirs.
  • They want those now living in the house who cannot be included in the reverse mortgage contract to be able to continue living there after the senior’s death.

Some seniors who should say “yes”:

  • Their incomes will drop on retirement while their mortgage payments continue.
  • They will retire before 65 but plan to delay social security until they are 65.
  • They are living on social security and want to supplement their income.
  • They are living on a nest egg, and fear it may run out before they die.
  • They need protection against a sudden drop in their income.
  • They want to buy a house but don’t want a monthly payment.
  • They need a way to manage fluctuating incomes and/or occasional expenses.

See When to Reject a HECM Reverse Mortgage, and When to Consider One,

 

March 8, 2021

Question of the Day“If annuities pay low interest rates, why do people buy them?”

Answer: The major concern of retirees should not be the rate earned on financial assets but the amount of spendable funds they can be assured of drawing over the remainder of their lives. In this regard, annuities can’t be beat. They provide more spendable funds and less risk than drawing from an asset portfolio.

For example, a retiree of 62 who uses half of his assets to purchase an annuity with payments deferred 5 years can draw about 10% more than if his payments come entirely from assets earning 5% -- which is a very high return in today’s market. Furthermore, the annuity payments run for life whereas sole dependence on financial assets leaves the retiree exposed to a market disruption.

The reason the combination of asset-draws and annuity results in higher payments is that insurers pay annuities only to survivors, who in effect benefit from those who die early.

For more, read Annuities: Much Misunderstood And Vastly Under-Utilized

 

March 6, 2021

Question of the Day“What Should Mortgage Shoppers Know About Rate Locks?”

Answer: A rate lock is a commitment by a mortgage lender to make a loan of a specified amount, secured by a specified home, at a specified interest rate and points. Points are an upfront charge by the lender. Third party charges, such as mortgage insurance, are not covered by a rate lock.

A rate lock facilitates home purchase transactions by assuring sellers that the buyers who have committed to purchase a house at a specified price have the financial capacity to do so. An increase in mortgage rates that occurs after the terms of the sale transaction have been set, which could otherwise torpedo the deal, will not affect it because of the lock.

While it could cost them heavily, lenders almost always honor rate locks when market rates jump. The rate lock is a legal obligation, and failure to honor it would put them out of business. This has happened but it is very rare and not something that mortgage shoppers should worry about. The issue that is much more likely to engage them is related to market rate declines, as opposed to rate increases.

While rate locks provided by lenders protect the borrower from rate increases, borrowers do not protect lenders against rate declines.

March 4, 2021

Question of the Day“Assuming that I remain in my house indefinitely, what is the most effective way to pay down the balance on my 30-year 3% mortgage so that I am out of debt in less than 30 years?”

Answer: To shorten the payoff period, you have to make additional payments on top of the scheduled payments, which were calculated to eliminate the loan balance in 30 years. For example, if a new loan is for $100,000 at 3%, a payment of $421.61 will pay off in 30 years. If you increase the payment amount to an even $500, you will pay off in 278 months instead of 360.

The longer you delay in making extra payments, the less effective they are. If you wait for 5 years before increasing the payment to $500, payoff will occur in 296 months instead of 278. But if you increase the payment to $600 after 5 years, payoff occurs after 245 months.

These numbers come from a calculator on my web site that allows you to model the effect of extra payments on the loan balance. Because no two users have the same financial capacities, and capacities usually change over time, the calculator is extremely versatile. Extra payments can be made monthly, bimonthly, quarterly, semi-annually, annually or one-time only. In each case, the user can specify when payments start and when they end. And up to 10 extra payments can be combined. You will find it at Mortgage Payoff Calculator: Extra Payments.

One thing that the calculator does not do is take account of the rate of return on the funds used as extra mortgage payments. If mortgage rates go back to 8%, which is the rate I paid awhile ago, borrowers with 3% mortgages will do better investing their surplus funds in assets that yield more than 3%. The objective ought to be to maximize wealth, which is financial assets less debt, not to minimize debt.

March 3, 2021

Question of the Day: “In comparing savings accounts, how do you take account of differences in the compounding period?”

Answer: The compounding period is how often the saver’s account is credited during the year. For example, if the rate is 12% -- not a realistic number but one that simplifies my example - and the compounding period is a year, the saver’s account is increased by 12% every year. If the compounding period is 6 months, the saver’s account is increased by 6% every 6 months. And if the compounding period is one month, the saver’s account is increased by 1% every month. The shorter the compounding period, the larger the increment to the saver ‘s account that reflects interest paid on interest.

Subject to a caveat, the best way to take account of the compounding period is to convert the interest rate offered into an effective rate that takes the compounding period into account. Most financial calculators have this capacity.

In the example above, the effective rates are 12% for annual compounding, 12.36% for semi-annual compounding, and 12.68% for monthly compounding. At a more realistic rate of 2%, the effective rates are 2%, 2.017%, and 2.018%. The lower the stated rate, the smaller is the effect of differences in the compounding period.

The caveat is that the compounding period defines the point when the saver’s account is credited. If the saver has a 2% account with monthly compounding and she needs to withdraw it after 11 months, she will get back 2% plus a little more but the saver with an account that has annual compounding will get no interest at all. Accounts offering frequent compounding provide value to savers whose accounts fluctuate.

See more at Mortgage Interest Rate Fundamentals

March 2, 2021

Question of the Day: Hi Jack. I heard somewhere online that one way to save years of interest on a 30 year mortgage is to do the following: Take out a 100 percent financed 30 year mortgage, and then, as soon as you close, send in a large principal only payment(ideally the 20 percent down that you would have put down to reduce the mortgage to an 80 percent financed mortgage). I ran this scenario on a mortgage calculator and it seems like it works - the mortgage is reduced from 30 years down to 14 years and the interest saved is in the tens of thousands all without a higher monthly payment, which a 15 year mortgage necessitates. How is this possible? Why doesn't everyone finance a home like this?

Answer: Control your excitement, what you are proposing is a loser. By raising the loan amount, you are increasing the payment, and that extra payment will result in early payment. You would get the same result if you used the same payment with the smaller balance.

For example, you borrow $100,000 at 4% for 30 years, generating a payment of $475.83. If you then pay off $20,000 but make the payment of $475.83, you will pay off in about 20 years. Now, if you don’t pay the $20,000 and borrow just $80,000 but make payments of $475.83, you will pay off in 20 years. This is the better option because the first will require a higher rate for a 100% loan, or mortgage insurance or both.

Click here for additional advice on paying off your mortgage early.

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