Last autumn I published a series of posts about “the economic vacuum cleaner,” the American way of financing “eldercare” that sucks up the estates of middle class Americans at an alarming rate. I will admit to a rather contrarian view of home ownership for those of us in our “golden years.” For far too many people, the conventional wisdom on home ownership has put them in a position where just a few large medical bills brings Tom Selleck and the “reverse mortgage” business to their door, and the outcome when that happens ends badly far too often.
If it sounds like I am picking on Tom Selleck here, I plead guilty. Selleck is the very-well-paid celebrity spokesman for AAG, the largest purveyor of reverse mortgages (technically called “home equity conversion mortgages” or HECM). His commercials dominate my television screen here in Florida, and I figure part of his job is to accept being the “ugly face” of this industry as well. Selleck likes to say, “This isn’t my first rodeo,” but for most of us, the prospect of declining health from age will be the worst time to confront a difficult mortgage decision. The power is very one-sided in this transaction.
Who likes reverse mortgages?
I have read a lot of pro and con feedback on experiences with reverse mortgages over the years, and I have found one common theme among the people who are happy with this financing route. The satisfied customers are almost always those who (1) really want to be in this home until the bitter end, (2) have few other assets besides that home equity, and (3) have resigned themselves to passing virtually zero assets on to their heirs.
Tom Selleck typically delivers on his earnest promise here. You usually get to stay in your house until you die or until your children drag you into a nursing home against your will. AAG will pay a lot of your bills until that happens, and very little home equity will typically remain to pass on to your heirs. With some better planning, however, I think this scenario does not need to happen so often. It does require some difficult decisions, however, and the earlier the better.
Who can escape a reverse mortgage?
In the spirit of this blog, I like to approach this issue as a kind of probabilistic bet. It is possible that the “cost of dying” could wipe out even a million-dollar estate. But if you have that big of an estate, and even much less, you also have multiple options for protecting your assets from depletion due to excessive eldercare costs.
Investment advisor Morningstar estimates that, of people turning 65 currently, 52% will need some form of long-term care in their lifetimes. The AARP estimates that, on average, those paying for this care out-of-pocket will spend an average of $140,000. Morningstar estimates the cost of lifetime care for someone with dementia at over $350,000. With those kinds of odds, betting that you will be “one of the lucky ones” is not a wise retirement strategy.
Statistically, this is an interesting catastrophe function, where, for maybe half of seniors, costs are minimal, but then the curve begins to rise steeply. Medicare covers up to 80% of the cost of the first 100 days of long-term care, and a good Part B supplement can cover much of the remaining 20%. However, for seniors with no liquid savings and with no Medicare supplement (or a bad one), that 20% of long-term care and any related medical costs can easily push the homeowner into a reverse mortgage right away.
And once you get past that point, long-term care costs escalate very quickly. This exact number is a difficult one to get a handle on, and thus another source of high risk. I have recently tracked how per-day costs in Florida can easily be twice that of, say, Oklahoma for the same level of facility. Average Connecticut costs are almost three times similar arrangements in parts of Texas. U.S. News and World Report pegs the average cost at over $90,000 per year for a semi-private room. Women are much more likely than men to require stays of more than one year, which also balloons this cost.
Long-term care insurance is obviously the simplest fallback position to cover most of this cost. However, besides being very expensive to obtain once you are over 65 (if you even can), the reality here is that the seniors most susceptible to the reverse mortgage decision most likely do not have LTC insurance, nor can they afford it.
Self-insurance, accomplished by segregating at least $100,000 into a safe investment account, is the second alternative, and the more you put in, the more your personal “catastrophe curve” flattens out. You can still get caught with a very long-term stay, but at least you are pushing your odds of financial crisis perhaps below 20%. And if you do not use those funds before you die, they roll into your estate. But again, the very people who cannot put those funds aside are the core of the reverse mortgage customer base.
Rethinking your high-equity home ownership
As I noted earlier, I am a contrarian to the common investment advice to rely on your home as your primary source of retirement security, especially if you do not have LTC insurance or are self-insured. Note that this is not so much about owning a home, but rather about the proportion of your estate value and cash flow locked up in real estate. Here are my reasons:
- Your house is an illiquid asset. I often use a personal finance mantra that money is choice. In other words, the more liquid your investments are (and standard market investment accounts are usually plenty liquid), the more choices you have in how to spend them. Standard IRAs are less liquid because of withdrawal tax implications. But a house is the worst. If all your equity is tied up in your house, a reverse mortgage becomes just about your only option to free up some cash on short notice, and that is not good. Undisciplined spenders sometimes see that illiquidity as necessary “forced savings,” but that approach comes with a big cost.
- Your house is an undiversified investment. A dictum of investment theory says that you never get any financial “bonus points” for sticking all your eggs in one basket. People richer than you are always able to diversify their holdings more than you can. You may get all the rewards if the value of your house goes up, but you also get all the losses if there is a housing crash at the wrong time, or if your community is a declining one. On a “beta” risk scale, houses are way up there compared with most market-based investments that you could convert to cash in seconds from your phone.
- Related to #2, I believe the vaunted profitability of home equity is overblown. Some people have made out like bandits in real estate. But for every seller at a high price there is a buyer. Most people get only modest gains from their houses compared with sticking the money in a well-diversified mutual fund and leaving it there over a couple of decades. And especially when mortgage rates are crazy-low, you may well be better off with half of your equity in a more diversified, more liquid investment fund, IF you have the discipline to keep your hands off it except in case of true emergency.
- Most people, in my experience, severely underestimate their personal total cost of home ownership (TCO). I will present a tool for accurately determining your TCO in a subsequent post, but basically, you throw all the cash you spend related living in your house annually into a pot, add the annual opportunity cost of your home equity, and divide it by twelve. This gets you closer to the “monthly rent value” of your current home. If you can satisfy your housing needs for less elsewhere, then you may have the opportunity to free up that “LTC self-insurance fund” for better protecting your estate.
The “opportunity cost” of your home is the annual income you could earn on a similar-sized market investment, and still keep up with inflation. I typically use a conservative 4% of the total equity value (house value less any outstanding mortgage), but I will explore this more in that subsequent post.
Importantly, this exercise is not so much about saving money in the sense of spending less, but rather saving money by redirecting any net reduction you can gain in housing costs into a safe investment fund for self-insuring against long-term care costs. Every $1000 saved into that fund will keep Tom Selleck away from your door for just awhile longer.
If you really love your home and adamantly do not want to move, then the TCO computation exercise will likely not change your mind. However, at some point, people over 65 need to face another reality, which is that this TCO will likely only rise as you increasingly need to hire help to maintain your property or make repairs to an ever-aging property
Downsizing, or even moving to senior rental housing while you can still make some choices and enjoy the community of others, may not be your first choice. But denial of the inevitable is not a good investment strategy. Everybody loses that bet. For those of us old enough to receive Medicare, our investment horizon is much shorter than for most of the rest of the market.
On that happy note…
A post in the queue will help you calculate your personal total cost of home ownership (TCO). To be notified of that post when it is available, you can subscribe to this blog by entering your email address in the box on the left side of the screen (or bottom if you are using your phone). Alternately, click on the Facebook or Twitter icons to be notified of new posts.
Some random thoughts.
Another factor is how property tax is calculated where one lives and the expected long-term trend in housing prices. In CO, voters repealed a state constitutional amendment that required a residential to non-residential property tax ratio of 45% to 55%. The legislature was required to adjust the residential assessment rate in order to maintain the mandated ratio. This saved homeowners quite a bit on property taxes over the years (critics said it resulted in underfunded schools, although the K-12 workaround was to pass millage increases in some school districts, along with a decrease in public funding for colleges/universities).
In 2020, voters exchanged that system for one with a fixed residential property assessment rate. However, property values have been on a tear here, due to low inventory and an influx of buyers from from the coasts. I’m pretty sure most of the “yes” voters thought their taxes would stay about the same because the percentage was now fixed, and didn’t understand that the assessed value will likely continue to rise, as will their property taxes. (I’m ignoring the TCJA of 2017, but that could be another factor in the future, without an increase in the property tax deduction limit.)
With respect to seniors, there is a senior property tax exemption of 50% of $200k of the actual value of the taxpayer’s primary residence (10 year occupancy requirement too), but it was enacted without a COLA adjustment, at a time when the median price of a single family home in the Denver area was in the ~$250k range; it is now double that. Without legislation action, seniors on fixed incomes will find it more difficult to stay in their homes.
Which brings me to issue #2. In CO, there is a trend toward creating special metro taxation districts for new construction, in which the developer pays for the development’s infrastructure through property owner financing, and then assesses the property owner for the debt obligation. There is no government oversight. If the developer feels like they need a “raise” they add more to the debt obligation and just pass that along to the property owner. Going out on a limb here, but I would say that most homebuyers do not understand the implications of living in a development that has a metro tax district, and don’t expect that their taxes will double from what they thought they would be paying in property taxes. Where I’m going with this is that a lot of these developments are being marketed aggressively to seniors as retirement communities.
On that happy note….
Good points. Florida does a lot of new development through Community Development Districts that can send your property taxes sky high for years. One issue found by reverse mortgagees is that they are still responsible for all maintenance and taxes even as their equity declines on their home. This requires them to take out more equity, but this means they are using house equity to pay property taxes. That is a very dead end.