When should retirees tap their home equity?

https://www.sciencedirect.com/science/article/abs/pii/S0378426623001656

{{ This paper analyzes a household’s optimal demand for a reverse mortgage. We study a rich life-cycle model that can explain the low demand for reverse mortgages as observed in US data. We find that the demand for reverse mortgages is particularly pronounced for cash-poor, house-rich retirees, and households with a strong bequest motive and low pension income. We analyze the optimal response of a household that is confronted with a health shock or financial disaster. If an agent suffers from an unexpected health shock, she reduces the risky portfolio share and is more likely to enter a reverse mortgage. If there is a large drop in the stock market, she keeps the risky portfolio share almost constant by buying additional shares of stock. Furthermore, the probability to take out a reverse mortgage is hardly affected unless her financial wealth is small. }}

There seem to be multiple opportunities for the promoters of this model to collect “skim”. Take out a reverse mortgage and invest the proceeds in the stock market??? {{ LOL }}

intercst

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The report was generated by the banking industry (Journal of Banking and Finance). Who has a vested interest in promoting second mortgages? There is probably something to it, but I suspect the balance point where it becomes a reasonable approach isn’t exactly where they draw it.

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I know someone that took a mortgage out on their home a few years ago at very low rates 2.??% and invested the proceeds into Apple stock. This was when Apple was paying a >2% dividend, and raising the dividend every year. Basically, the dividend covered nearly the entire mortgage payment, and in year or two later, the dividend was greater than the mortgage payment. Not to mention that the price of the stock also went up since then.

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The math on that does not add up when you consider the fact that the mortgage payment would include principle and interest.

500k loan at 2.5% would have a monthly payment of $1976, or $23,712 a year, or about 4.7% of the amount of the original loan. You would need to earn that much in interest (4.7%) to cover the monthly payment.

The ONLY way your friend’s idea works is with a floating rate loan that requires a payment of interest only - and your friend would likely be sweating bullets right now over the fear of that rate adjusting higher in our new rate environment.

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I just went back and looked at the discussion way back then. It was a 7/1ARM at 2.83% (dividend was 2.63% at the time) and he said the dividend [nearly] covered the interest, and that he got a preferred rate for the loan due to it being low LTV. Closing costs were about $3000. This was about a decade ago, and the trade worked out spectacularly well for him.

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A 7/1 ARM from ten years ago likely has a 5.83% rate today (7/1 ARMs are usually allowed to increase the rate by 1% per year after the first 7). I am quite confident the dividend no longer covers the interest of the loan.

Actually, most ARMs that I saw from ~10 years ago had 2% annual change caps, with a maximum of a 5% lifetime increase and a floor rate that was equal to the original base rate. That said, even if a change in 2019 or 2020 maxed out the annual cap up to 4.83%, it’s likely that the 2021 change would have brought the rate back down to the floor rate of 2.83% If the 2022 and 2023 changes each maxed out the annual cap**, the current rate is likely to be 6.83% (or 4.83% with a change to 6.83% before the end of the year). If the 2023 change hasn’t occurred yet, the rate is likely to be 4.83% with a projected change to 6.83% by the end of 2023.

**If the mortgage anniversary date is in the first quarter, the 2022 adjustment probably would have been an increase, but would not have maxed out the annual cap. However, it’s quite likely that the 2023 and 2024 adjustments have/will each max out the annual cap. So the current rate might be 5.83%, but it could very well be an increase to the lifetime cap of 7.83% with the change in the first quarter of 2024.

That’s quite likely, unless there have been additional principal payments made.

AJ

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Oh, he ended the trade and paid off the mortgage long ago. When the stock was up about 5X, all he had to do was sell 1/5 of his shares to pay off the entire mortgage (other than tax effects, of course). The trade worked out quite well for him. Had he waited till now, the stock would be up 10X or so, but I’m pretty sure the mortgage ended before the first ARM adjustment.

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