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What does dairy farming have to do with explaining a reverse mortgage to your clients and referral partners? I grew up on a dairy farm in Wisconsin and even though I have not milked a cow since I was 18, I’ve found that it’s a great way to communicate with my clients. I rarely speak to a client or a financial planner without pulling out my legal pad and drawing one or both of the two diagrams accompanying this article. First, let’s talk about the three buckets that are not filled with milk, but with financial assets.
Three Buckets
My three buckets represent sources of income. The first bucket represents monthly income like Social Security payments, wages and pension income. Some people can tell you the value of this bucket to the penny.
The second bucket represents retirement savings or the nest egg—a lump sum of everything from savings accounts, IRAs, CDs and 403bs to change jars and gold coins. This value is harder to determine, but this bucket spins off a certain amount of income, either in interest and dividends or simply cashing in the principal. This money was put away years ago and was designed to be spent in retirement. My clients’ biggest worry is that they’ll outlive the life of this bucket. Financial professionals spend almost 99 percent of their time analyzing, projecting, sifting, calculating and recalculating the value and use of the first two buckets. Most never consider the third bucket.
The third bucket is the equity in my client’s home. Interestingly enough, the third bucket—depending on my client’s other assets—is usually valued at 30 to 50 percent of my client’s net worth. Yet most financial professionals largely ignore bucket No. 3.
Of course, as reverse mortgage professionals, we spend a majority of our time on bucket No. 3. I spend a significant amount of time explaining to my clients that their home is fungible, that it can be reduced to dollars. Clients must be able to understand the fundamental difference between their home, perhaps the most intimate object of their lives, and their home equity. The fact that we live in this asset dramatically affects our attitude toward using it as a retirement tool. But the truth is, we can’t take it with us and sooner or later our house will be liquidated and denominated into dollars just like our IRAs.
Because of this psychological brick wall, many clients refuse to consider their home equity as a source of income and choose instead to use it as a retirement drain. (See the two arrows by the third bucket, as they can go either way.) The
typical retiree takes money out of the first two buckets to fund the third bucket. They pay taxes, insurance, maintenance and often a continued monthly house payment when they are past the age of 62. They no longer have to do that using buckets Nos. 1 and 2. How many retirees are still contributing to IRAs? Very few! But how many are still contributing to bucket No. 3 and plan to do so until the end of their life in the home? Most of them. Why do most retirees and their advisors have no problem with taking money out of the IRA or savings account to fund retirement income, yet when we suggest a reverse mortgage, they are sometimes aghast at the suggestion and decide to wait until bucket No. 2 is empty before calling us right around age 92? After all, they put money into the second bucket so they would have something when they retired. We must remind our clients that they also religiously put money into their home in the form of payments, improvements, taxes, etc. In its simplest form, a reverse mortgage is nothing more than a tool that turns home equity into cash without affecting your ability to live in your home. It allows you to withdraw money from bucket No. 3 instead of continuing to contribute to it.
I have used this simple drawing to help my clients and their advisors overcome the psychological barrier of withdrawing money from the third bucket. Of course, there is still one argument that comes up often: What about the heirs?
First, the heirs should be more concerned about Mom and Dad—and they usually are. But sometimes Mom and Dad are the ones who worry about how much they are passing on.
Obviously, if you take money from the third bucket, there will be less home equity for the heirs, especially once you consider the negative amortization of a reverse mortgage. But, there will be more money and appreciation in the second bucket. I encourage my clients to ask their children which bucket they would rather have more assets in—the second or the third—and most choose the second bucket. Those assets are easier to quantify and, ultimately, easier to distribute. Anyone who has ever tried to sell houses in an estate can relate to that. You have to pay utilities, taxes and upkeep, and take care of the place while dropping the price to find a quick buyer. Preserve bucket No. 2 with bucket No. 3.
The bottom line is those two buckets of milk from my farm were the same milk. It did not matter which one you sold to the dairy; both had the same value when you poured it out. We need to work with our clients to help them realize this. The money is the same in both buckets Nos. 2 and 3. When you pour out both buckets, your income will be greater and your retirement money will last longer. Was that not the plan from the beginning?
The Two Silos
This discussion simply addresses the emotional need to eliminate mortgage debt. We stored haylage and corn silage in our silos on the farm. The contents of the silos were used to feed the animals in the winter when they could not graze on the snow-covered pasture.
I draw a picture of the two silos for my clients who are worried about having mortgage debt. When they are young, first-time homebuyers or middle-aged clients refinancing or moving up, I encourage them not to be so concerned about using all their excess monthly income to make extra monthly payments to try to get their liability silo down to zero. While that seems to be a good goal, it stops them from filling their asset silo. The more effort and money poured into decreasing debt, the less money will go into their future retirement. They would like to drop all of their debts and mortgages to zero, but that comes at the high cost of not being able to save as much when they are young and enjoying the effect of compound interest. There are many mathematical calculations that prove saving, instead of doubling up on your payments, is better for your long-term net worth.
So how does this apply to the emotional aversion to taking out a reverse mortgage? Well, many of our seniors have almost emptied out their liability silo and are glad that their mortgage is almost down to zero. Now we come along with the idea of increasing debt instead of decreasing it, which many seniors have been doing for years. It is certainly true when you take out a reverse mortgage that your liability silo volume will start increasing. It is important that we show our reverse prospects that the cash silo will now start increasing, or simply not decrease as fast as it was.
We need to show our clients that it is OK to stop making payments to real estate that must come out of our asset silo. While our left pocket might be losing some change, our right pocket has more, so we are not going backward as far as our overall net worth goes. Some of the research by Dr. John Salter at Texas Tech proved that most who properly used their reverse mortgages to keep the asset silo preserved actually had a better net worth than those who did not use a reverse mortgage. Math is factual—there has to be a loss somewhere for
there to be a gain elsewhere. As long as the gain is better than the loss, your clients will be ahead of the game. Unfortunately, many clients (and advisors) make emotional decisions instead of logical, mathematical ones. But a picture can be worth a thousand words, so maybe my two very basic diagrams can help your clients see the clear advantages of reverse mortgages in retirement, even if they have never been on a farm!
