An NYT story says,
it may surprise you to learn that some community bankers are quietly offering the loans, too, bringing a kind of Main Street respectability to a product that has long lacked it.
Pointer from Tyler Cowen.
Here is how I think of a reverse mortgage.
Step 1. Sell your house to the bank.
Step 2. The bank rents your house back to you.
Step 3. The bank forgives the rent, but instead charges you interest that accumulates until you die or move out.
Step 4. When you die or move out, the bank adds up the accumulated unpaid rent and interest. If you want to pay it up, you can get your house back. Otherwise, if the debt is higher than the value of the house, then it makes more sense to let the bank keep the house.
In principle, whether this works out financially depends on how long you live in the house relative to expectations at the time you take out the reverse mortgage. You want to live so long that the value of living rent-free in step 3 is so high that at step 4 you or your heirs gladly hand the bank the house rather than pay all that rent and interest. But if you move out or die relatively soon, the bank will have priced the mortgage in such a way that if you or your heirs pay off the debt the bank will come out ahead–and it will come out ahead even more if you give up the house.
Thus, as in any sort of life insurance or annuity situation, you are making a bet against the financial institution. My guess is that this is unwise.
1. In general, the individual loses bets against financial institutions. I tell my daughters, “remember that insurance companies always price to make a profit.” My point is not that you should never buy insurance of any kind. But you should always at least consider self-insuring (rather than paying for extended warranties, for example) or alternative ways of insuring.
2. I think that old people are inclined to over-estimate how long they will live in their houses. They do not like to think about how they might lose the ability to climb steps, to tolerate bad weather, or to live independently.
3. I do not think that many old people need to live rent-free in the short run. In the short run, you can just take out a regular mortgage and use some of the proceeds from the mortgage to meet the payments. Ten years from now, after you have used up most of the proceeds on making the payments and financing consumption, you can think in terms of selling the house. By that time you will probably want to. See (2).