How to decide when to take out a home mortgage and whether to pay it off early. How reverse mortgages can be a helpful retirement tool.
Topics covered include:
- Why it is more difficult to get a mortgage today
- How federal government mortgage guarantees lead to lower mortgage rates
- How to analyze whether to pay off your mortgage early
- The differences between personal risk, market risk, and aspirational risk
- How reverse mortgages work and how they can be useful as a retirement income tool
- What are the costs of reverse mortgages
Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode, 349. It’s titled “Forward and reverse mortgages—when to take them out and when to pay them off.”
A home mortgage is debt secured by a house. I had never heard of the term “forward mortgage.” We typically just think of a mortgage. I had heard of a reverse mortgage. The difference between a forward mortgage and a reverse mortgage is with a forward home mortgage you have to make monthly payments of at least interest, but typically interest and principal, whereas a reverse mortgage is a way to tap into the equity of your house. You can receive a lump sum or a series of monthly payments, but you’re not making payments to the bank or the holder of the mortgage until the house is sold or you passed away.
We’re going to take a look at both types of mortgages in today’s episode. The word “mortgage” is old French, and literally means “death pledge”, which is kind of an ominous-sounding word. But there have been a lot of mortgages taken out over the past year.
In the U.S. typically there’s about 400 billion to 600 billion dollars worth of new homes mortgages originated each quarter. That was from 2007 to 2020. But in 2020 and into 2021 things changed. The last three quarters have seen new mortgage originations—these are forward mortgages—of over a trillion dollars. Over $700 billion of those quarterly mortgages were granted or taken out by individuals with credit scores over 760. So most of the growth has come from households with very good credit.
Interestingly, about $400 billion of new mortgage originations were individuals over the age of 50, and about 200 billion were over 60. Individuals approaching retirement or in retirement are still taking out mortgages, rather than fund the home purchase from their existing assets. That’s one of the things that we’ll look at—should we take out a mortgage, or should we just fund it out of cash?
Government Involvement in Mortgages
Over a decade ago, LaPriel and I paid off our home mortgage. We wanted to feel unencumbered, and it felt great. We didn’t have to make a monthly payment anymore. But then as mortgage rates began to fall and hit historical lows in the U.S, we decided that we wanted to take out a mortgage. This was last fall. We were originally going to use it to help fund our purchase of a house in Tucson, but it took so long to get the mortgage; we’d paid cash for the house, and after five months got the mortgage and were using it for the home remodel.
We started the process with a mortgage broker that was recommended by our realtor in Phoenix. Unbeknownst to me, the regulations changed; the requirements for income verification changed due to the pandemic for self-employed individuals. Those requirements are set by Fannie Mae and Freddie Mac. Fannie Mae is the Federal National Mortgage Association. It was founded in 1938. Freddie Mac is the Federal Home Loan Mortgage Corporation, founded in 1970. These are wholly owned entities of the federal government and are there to provide a source of funding for residential mortgages in the U.S. Fannie Mae and Freddie Mac guarantee mortgages against default. They buy up those mortgages and they package them into a pool of loans known as mortgage-backed securities.
70% of home mortgages originated in the U.S. are bought by Fannie Mae and Freddie Mac. And if we include the Government National Mortgage Association (Ginnie Mae) and the Federal Home Administration Loans (FHA), the U.S. federal government guarantees 92% of mortgages issued in the U.S. That federal guarantee is one reason why mortgage rates are so low in the U.S. And we discussed Fannie Mae and Freddie Mac securitization and how the U.S. is more socialist than Denmark regarding home mortgages. That was episode 238.
These new requirements to get a mortgage if you’re self-employed were due to the pandemic, Fannie and Freddie, which are guaranteeing these mortgages, wanted to make sure the borrowers had stable income, and that there was a reasonable expectation that it would continue. So they wanted year-to-date profit and loss statements, they wanted three months of bank statements, and that seemed to be for whatever reason the challenge this mortgage company had reconciling the monthly bank statements with the P&L statement. I have no idea why. It got extremely frustrating.
The last I heard from them was in December, and they were sending the loan package to the credit committee to make a final decision, and I never heard back. At that point, I turned to a member of Money For the Rest of Us Plus that I’ve known for several years, Gavin Walker. He’s a mortgage broker, a very good one because he knows what the requirements are, and he was an advocate for me in working with the underwriting team, taking the information, making sure it was accurate, but presenting it in a way that the underwriters could use it. He wasn’t simply an order taker, a go-between between the mortgage applicant and the underwriters. He knew what was needed, and the loan closed in March.
Now, we didn’t need a mortgage. We could have just paid cash, which raises the question “If you have the assets, should you pay off your mortgage?” If you have equity in your house, should you get a reverse mortgage to help fund your retirement? And where does a home and mortgage fit in your overall asset allocation?
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