Q: I have an 82-year-old aunt who has a personal friend and financial adviser pressuring her to take out $200,000 in a home mortgage because he has told her he can get a 7 percent to 8 percent return on her money. While I was visiting, he called. He was very insistent about the urgency of making this investment. I live about 1½ hours away, so I don’t see her often. My aunt has a $3,500 monthly annuity, a home valued at $500,000 and an investment account. I don’t know the value of her investment account. I am designated as executor of her estate. I told her I felt this was very risky at her age. She told me her money would be invested in “programs.” She could not be specific about the details. I have a very bad feeling about this. Is there any thing I can do?
A: You’re right to be very concerned. You can tell her the facts and show her this column. Anyone who says, with confidence, that he can get a 7 percent to 8 percent return in today’s market is either a fool or a salesman without a conscience. (Possibly both.) Let me outline the risks that this proposal involves:
A 30-year mortgage for $200,000 at 4 percent interest would have a monthly payment of $955. That’s a total of $11,458 a year, or 5.7 percent of the amount borrowed. Your aunt would be committed to this payment regardless of the income produced by the proposed investment “programs.” When someone describes an investment as a “program,” he is usually talking about a private, nonliquid investment. So if the investments failed to produce the 7 percent to 8 percent return, she would have to get the $11,458 a year from another source — such as her annuity or investment account.
Either way, any degree of failure would result in an immediate and permanent decline in her standard of living. Equally important, her potential income gain, if the investment is successful, is not great due to the monthly cost of the mortgage. If the investment actually produces an 8 percent yield, her income would be $16,000, less the mortgage payments of $11,458 a year. That’s a net gain of only $4,542 a year — about $379 a month. She’s taking a lot of risk for not much gain. That net gain, by the way, would be taxable, so the increase in her spendable income would be still less.
But suppose she really needs more spending money. Is there any way she can get some additional spending money without taking a lot of risk?
Yes. She can still borrow against her house. She can do this with either a home equity credit line or a reverse mortgage. If her house is worth $500,000 in the current market, she could draw $379 a month, tax-free, for a bit more than 25 years before the principal and accumulated interest on her withdrawals reached $200,000. So she can borrow without taking investment risk.
During that time, the house may increase in value, perhaps enough to offset the accumulated loan amount. If the house appreciated by only 1 percent a year, for instance, it would increase in value by $142,000 over the same 25-year period. If it appreciated at only 2 percent a year, the house would increase in value by $324,000, fully offsetting the growing debt.
During that entire period, any interest she paid could be a tax deduction. The scenario would be similar for a reverse mortgage. Either way, she would not be taking on the risk of an unknown investment that could decline in value. She would only be taking on an obligation that is likely to be offset by inflation for as long as she lives.
If she really needs more income, it is likely that she is “house-poor” and has to spend too much of her income supporting her $500,000 house. So a still better plan would be for her to “right-size” her shelter, moving to a smaller, less expensive house and investing the difference. Another option would be to move to a continuing care retirement community.
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