A reverse mortgage is a great way to profit from inflation by shorting the purchasing power of the US dollar

Shorting USD inflation

I recently wrote that your basic home with a mortgage was the world’s greatest short. You are shorting the US dollar losing purchasing power and you are doing that by borrowing a bunch of them.

The way the famous Wall Street shorts work is you sell a stock or option before you buy it at the expiration date of the option in the hope that it will fall in price below what your buyer has to pay you in the future. Such shorts have a limited upside but an unlimited downside-because the stock price can only fall to zero but there is no limit on how high it can go.

This short that I am advocating here is, “Neither a borrower nor a lender be, unless there is inflation, in which case being a mortgage borrower is very profitable.” (apologies to Shakespeare)

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Real = adjusted for inflation

The real mortgage balance is its adjusted-for-inflation value. For example, my wife and I got a new $450,000 mortgage at 2.999% in 2021. The nominal balance—the one printed on each monthly statement—is now $439,004.76. But the real balance is $397,068.66 because the dollars we borrowed were 2021 dollars, but we are now paying it back with 2023 dollars which have less purchasing power. There is a Consumer Price Index calculator at the Bureau of Labor Statistics website. https://www.bls.gov/data/inflation_calculator.htm

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I entered the origination date of the mortgage into the CPI calculator: July 2021. Then asked it what the adjusted for inflation real balance of the mortgage was in March 2023, the most recent date in the calculator.

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Now let me go back 20 years to 2003. I will guess that the house was worth about $800,000 then. Let’s say we got an 80% mortgage. 80% x $800,000 = $640,000. In 2003, mortgage interest rates were about 7%. Had we got such a mortgage and kept it until now, the nominal balance would now be $368,827. And what would the real balance be adjusted for the inflation that occurred since 2003. The CPI calculator says that is $224,716 in 2003 dollars.

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So our real equity today would be our current value, say $2.5 M minus the real balance of the mortgage of $224,716 = $2,275,284. The profit we made from shorting the US dollar by getting a fixed-rate mortgage and paying it for 20 years would be $368,827 - $224,716 = $144,111.
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Personal residence ‘life estate’

Reverse mortgages in the US are nonrecourse and as long as at least one borrower spouse:

• lives in the house as their principal residence 51% of the days of the year
• never stays out for more than one year (3% of seniors live in nursing homes)
• keeps the property taxes current
• keeps the house insured
• keeps the house maintained

the lender may not foreclose. If both spouses are going to be away for 60 days or more, you have to notify the lender and make arrangements to check on and watch over the home.

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Life estate versus reverse mortgage

That is not quite the same as a life estate. In a regular life estate, the life tenant(s) can do whatever they want with the property until they die other than “commit waste.” That means let the property deteriorate. They can live in it, rent it out, move into a nursing home, whatever. They still get to use it for any purpose until they day they die.

The reverse mortgage could be called a single-purpose (principal residence) life estate.

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Set aside for paying property taxes, insurance and upkeep

If you look like you cannot even pay the property taxes, insurance, and maintenance, they may still make the loan to you, but they will set aside enough of the loan proceeds to pay those expenses for the borrower’s likely remaining life span.

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Remainderman

In a life estate, the person who gets the property when the life tenant dies is called the remainderman. In a reverse mortgage, the heirs of the borrowers are the remainder men. but they must pay off the reverse mortgage.

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Nonrecourse

If the reverse mortgage balance goes above 95% of the current value of the house, tough luck for the reverse lender. They can take the property when the borrower moves out for more than a year, or dies, and sell it. But what they get from the sale is all they are entitled to, even if it is not enough to pay off the mortgage balance at that time. The terminology for that is a nonrecourse mortgage.

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House value rising

The house always has a value. The value of the life estate plus the value of the remainder estate equal the total value of the house. Initially, the life estate has high value based on the relatively distant likely death date of last of the borrowers. And the difference between the total value and the life estate is the value of the remainderman estate. With each passing month, the life estate becomes less valuable and the remainder estate becomes more valuable.

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There was a famous case in France where an old lady had a life estate. She outlived her remainderman. And almost outlived his widow.

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“Neither buyer nor seller knows in advance how long the [life estate] will continue. And it backfired for the notary (official who handles property transactions) who bought an apartment [remainder estate] in southern France from Mme. Jeanne Calment. She outlived her purchaser and his widow continued the [waiting for the apartment] for 32 years until Mme. Calment died in 1997–at the age of 122.”

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Methuselah

The remaindermen must fear that the life tenant turns out to be Methuselah. They can hedge by purchasing an annuity that starts the year the last life tenant is expected to die The annuity payments until the life tenant dies are the compensation for the person turning out to be Methuselah.

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Generally, a person cannot buy insurance, or an annuity which is a form of life insurance, on another person unless they have an insurable interest in that person. By being a remainderman, that person does have an insurable interest in the life tenant.

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Premature death

By the same token, the life tenant might die early. The lender sort of gets screwed by that because they stop earning their 9% or whatever. Mortgage lenders do not like making mortgage loans that only last a year or two. Too much trouble for too little total cumulative interest income.

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When the remainderman(men) is(are) your children, they, one hopes, are not wishing you would hurry up and die so they could get their hands on the equity above the reverse-mortgage balance. But it would be logical for them to hedge the Methuselah possibility by buying an annuity on the borrower. Although in general, such cash annuities suck in inflation/

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Annuity in kind

As a writer on hyperinflation, I hate cash annuities. They become worthless in hyperinflation. But note that the life estate is an annuity in kind, not a cash annuity. The right to live in a house rent free and mortgage free is worth the rental value (less the property tax, insurance, and repairs) each month and it instantly, automatically adjusts upward for inflation. It does not get destroyed by it.

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So called inflation index clauses like in Social Security are NOT instant. You get a raise in January based on calculations done in November using price data collected in August. In hyperinflation, that enormous delay is a colossal joke on you.

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The reverse mortgage does not give you this. You already have it. If you own a home with substantial equity, you already get to not pay rent but you do have to pay the taxes, insurance, and maintenance. That is the case with either the reverse mortgage or just having equity in your home. If you get a regular mortgage, you jack up your monthly mortgage payments. With a reverse mortgage, you get the lump sum cash proceeds but no additional monthly payments.

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I think the heirs or some of them could also move into the house with the borrower if circumstances said that make sense. They would have to pay off the reverse mortgage to remain after the last borrower dies.

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Can you buy a home using a reverse mortgage?

Yes. You do not need to qualify to make the monthly payments because there ARE no monthly payments on a reverse mortgage. But you need to be old enough—62—and you would have to put about 50% down. And you need to convince the lender that you will pay the property taxes, insurance, and maintenance.

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What do you plan to do with the mortgage proceeds?

You ought to put the proceeds into investments that pay more than the after-inflation cost of the mortgage with regard to the negative amortization of the reverse mortgage. You are essentially converting the amount of the mortgage and interest from real estate equity into whatever you put that into. If it is not a better investment, you should question why you are doing it.

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You are entitled to do, if you wish, what a famous bumper sticker said, “being of sound mind, I spent it all when I was alive.”

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Just get a lump sum. That is no longer permissible with a HECM FHA mortgage. But it still is with a jumbo second reverse mortgage.

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Your heirs’ perspective

If your heirs are good people, not like the Menendez brothers, they will wish you long life and tell you that your home equity is all yours to do with as you please. None of their business.

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Yep. However, the duration of your life is uncertain as are the inflation rates and home values and such. As remaindermen of a sort, they have a financial interest in any equity and in taking steps that would preserve or increase that equity and minimize taxes on it.

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Should your heirs pay down a reverse mortgage?

For example, they could preserve equity by paying down your reverse mortgage in part or totally. When you pay down the principal portion of a loan of any kind, the return you get on that investment is the interest rate on the loan. A jumbo reverse mortgage today might have an interest rate of 9.99%. If you pay that down, your yield on that investment is 9.99%. Is that an attractive yield in today’s market? Hell, yes. If you do not pay off enough to reduce principal, you at least reduce the compounding

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But a how does a non-property owner benefit? By being an heir and the will saying that if there are multiple heirs and not all of them contribute to paying down the mortgage, the one who does pay down the reverse mortgage gets all of the resulting increase in equity. Then, if, say, there are three heirs total, they would split the equity that would have existed if the one had not paid down the mortgage equally three ways. But the heir who paid the mortgage down would get all the equity that resulted from that pay down. That means the 9.99% is compounded.

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This assumes that the property has equity in terms of property value. If the property value falls or does not go up much, how that equity is split between the heirs could possibly result in the heir who paid down the mortgage not getting full benefit of that.

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Spread sheet

To analyze this, I created an Excel spread sheet. 30 rows representing future years. Columns labelled:

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Year

Assumed inflation rate

Home value

1^st mortgage nominal balance (amount the amortization table says you owe)

2^nd mortgage nominal balance

Nominal equity (property value minus the two mortgage balances that year)

Real equity (property value minus the real adjusted for inflation mortgage balances each year)

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There is one cell in the upper left where I put the assumed inflation rate. That rate is then applied to the property value and to the adjustment of the mortgage balances to get the real balances. The formulas for calculating each year’s numbers refer to the year before and use the inflation rate cell putting dollar signs in front of the coordinates of the inflation rate.

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In my case, the inflation rate cell is B2. So in the formulas for each year’s property value and real mortgage balances, the inflation cell I designated $B$2. For example, the first row under property value if the current Zillow or Redfin or whatever home value estimate. That is in C3. The formula for C4, the 2024 home value is =C3*(1+$B$2). That means multiply the 2023 home value by 1.05 (for the run where the inflation rate is assumed to be 5%).

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So if the 2023 value is $2,500,000, the 2024 value will be $2,500,000 x 1.05 = $2,625,000. Then you just copy and paste that C4 formula in the next 28 rows. That will automatically insert the last row above as the first number in the formula, but because of the dollar signs it will always add the same $B$2 to 1 to get the inflation rate. So the C5 formula is =C4*(1+$B$2) and the C6 formula is =C5*(1+$B$2) and so on.

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With the real mortgage balance columns, the inflation LOWERS the number rather than RAISES it as with the home value. So the row entries for the existing first mortgage amount I just transcribed from an online amortization schedule. I know the formula from having studied time value of money in real estate and at Harvard Business School, but it is quite complex. For 30 entries, transcribing was quicker. To convert the nominal mortgage balances for each year to the real balance I used the formula =D3*1/H48. D3 is the nominal mortgage balance from the amortization table. H48 is 1 plus the assumed inflation rate. I should have made it simpler, namely D3/H48. Same result.

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This is called a sensitivity analysis. So what does it show?

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Inflation rate    result

1%       all real equity belongs to the lender after 16 years

2%       all real equity belongs to the lender from year 14 to year 16, then the borrower starts rapidly building equity because, in our case, the first mortgage is paid off in the 15^th year

3%       borrower’s real equity grows every year to 243% of the starting equity in the 29 years

4%       borrower’s real equity grows every year to 324% of the starting equity in the 29 years

5%       borrower’s real equity grows every year to 432% of the starting equity in the 29 years

6%       borrower’s real equity grows every year to 574% of the starting equity in the 29 years

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The average U.S. inflation rate from 1960 to 2020 was 3.8%.

Now, assume an inflation rate akin to that in 1981, 13.5% or January 1919, 17.9%:

20%     borrower’s equity grows every year to 23,738% of the starting equity in the 29 years ($414M house) Prospective home buyers of the $414M house would then be making $40M a year or some such so they could afford it. Basically, in hyperinflation, the value of the USD falls to a fraction of a cent and it takes a lot of fractions of a cent to come up with $2.5 M. 414M of them in this case.

Hyperinflation last for 5 to 24 months

Now as my book on hyperinflation says, inflation would not be 20% for 29 years. In fact, I predict, it will last for 6 to 24 months in the US. Then it would end either because the US government let you use whatever currency you wanted (e.g., 2009 Zimbabwe) or because they introduced a new dollar with a believable story about why it would not inflate (e.g., 1923 German Rentenmark).

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However, although that ends inflation in the economy, it does NOT undo the purchasing power loss to lenders like our mortgage lenders. Their loans become worthless thereby greatly enriching all the borrowers who owed them in real terms. And they stay worthless forever.

Stepped-up basis

The home owner with heirs should prefer to bequeath the house to his or her heirs in order for them to get stepped-up basis. That means if they sell the house immediately after the death of the home owner, they get the equity federal income tax free. If the home owner gives the house to their kids before they die, the kid’s basis is not stepped up. Rather, it is the basis of the home owner, which is what they paid for it plus any improvements they made when they owned it. If the heirs sell it immediately after getting it, they would have to pay all the capital gains tax that the prior owner would have had to pay if they had sold it.

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Reasons not to sell before you die

If you sell before you die, you typically will owe capital gains taxes. Also, There are typically substantial transaction charges—9% to 10% according to homelight.com. If there is little equity for you after such costs, do not incur them. Let the lender incur them. Or sell in a deal where major costs like commission and title insurance are avoided.

What should the heirs do if there is no equity?

Is the home owner dies or moves out for more than a year, and there is no equity, the heirs should clean out the personal property that they want in the house, assuming the will left it to them, then walk away from the house and the personal property they do NOT want. If the reverse mortgage borrower has not yet died, but is in a nursing home, the personal property would belong the them.

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If and when being a reverse mortgage borrower happens to you, you will adopt a tenant mentality. Pay as little as possible for upkeep and make no unnecessary improvements because any benefit to you would only be short term and would not benefit your heirs at all.

What should the heirs do if there IS equity?

Do not let the lender foreclose, If they foreclose, THE LENDER gets to keep all the equity as an extra windfall profit. If the house has equity and the owner of it dies or moves out for more than a year, the home owner or his or her guardian must sell the house and pay off the reverse mortgage. They then get to keep the excess sale proceeds above the reverse-mortgage balance.

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If the house was sold by the local government for non-payment of property taxes, any excess proceeds of the sale would go to the home owner or his or her estate. But that is NOT the case in a foreclosure. There, the lender gets to keep the excess proceeds. Generally, the lender would never allow the house to be sold for unpaid property taxes. Rather, they would pay the property taxes and foreclose on you for not paying them.

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There are annual limits on how big of a reverse mortgage you can get.

For a HECM (FHA) first mortgage, the limit is now $1,089.300. On a jumbo non-HECM it is now $4,000,000. It changes every year according to inflation.

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Contraindications

There are a number of “welfare” type payments‚ government charity or financial aid that conflict with a reverse mortgage. You need to make sure you understand the effect on you if you get or are about to seek any such payments or government freebies. In some such cases, the mortgage loan proceeds or part of them would just go straight to the government agency with no benefit to you at all but confiscation of some of your home equity. In many cases, home equity is not considered for eligibility for some government benefits. But if you convert the home equity to cash via a reverse mortgage, you have converted an untouchable asset into a confiscatable one.

What if you have no equity, but you are still alive and have not been forced to move out for more than a year by health?

Stay in the house. Since you only have to pay taxes, insurance, and upkeep, it is probably the cheapest housing you will be able to find. According to Zillow, the current rent value of my house is $6,211/month. My property taxes and insurance are about $1,000 a month. And that plus upkeep are all I would have to pay to stay in the house.

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It is possible you might have to pay less than $1,000 a month in another smaller, less well-located house. But absent that, staying in the house with the reverse mortgage until you die or are forced to move out by health makes the most sense.

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What if you go into a nursing home for more than a year, then get better and leave the nursing home?

I have heard of one situation in Berkeley, CA where a woman went into a nursing home. Her nephew rented out her house. Then she got better and tried to return to her home. She was permanently prohibited from doing so by Berkeley rent control laws.

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A reverse mortgage could produce the same result. You move into a nursing home for more than a year, then get better and want to go home. But you no longer have a home. The reverse mortgage lender sold it when the first anniversary of your move out arrived.

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That could be a disaster. You might still have some assets other than the home and maybe some income like pensions. And hopefully, you would have family and/or friends to help you. But some people have no such people.

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There might be some way to insure against that eventuality. There should be.

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What it mortgage market interest rates drop to an attractive rate?

There is no prepayment penalty on a reverse mortgage so you should refinance. You should consider paying off a high-interest-rate reverse mortgage with a normal first or second that has monthly payments if you can safely afford to make them.