After a long binge of borrowing, U.S. consumers face a credit crunch and a sagging economy. To sustain their living standards, many Americans are doing what comes naturally: scrambling to raise more cash.
Sheron Brunner, 63 years old, bought a $250,000 life-insurance policy in 1997, planning to leave the proceeds to her three children. She faithfully made her $113 monthly payments. But after retiring in 2002 from her job running a homelessness-prevention program, her finances unraveled. Health problems forced her to siphon her savings. A monthly Social Security check of about $700, her only source of income, doesn't cover her medical bills and rising everyday expenses. In September, she moved to Wichita, Kan., from San Francisco to cut her cost of living.
It wasn't enough, so this spring she signed what's known as a life-settlement agreement with J.G. Wentworth, a company that buys life-insurance policies and other tough-to-sell assets. The contract transfers ownership of a life-insurance policy to a third party, who then pays future premiums and collects the benefit. Ms. Brunner received about $45,000 for her $250,000 term policy.
'It wasn't what I wanted,' she says. But 'with the economy the way it is, I needed that help now.'
As consumers max out their credit lines and banks clamp down on lending, many older and middle-class Americans are resorting to pricey, often-risky alternatives to stay afloat. Some are depleting their retirement accounts, tapping 401(k)s for both loans and hardship withdrawals. Some new fast-cash options allow homeowners to squeeze equity from their houses -- without the burden of monthly payments. One new product offers a one-time payment. In exchange, the company gets up to 50% of any future change in the property's value, typically collecting its share when the house is sold.
Americans are resorting to these more extreme measures due to the combination of dwindling jobs, falling home prices, shaky credit markets and a sharp run-up in food and energy prices. Consumer confidence hit a 28-year low in May, according to the latest Reuters/University of Michigan survey of consumer sentiment. Consumer spending and income inched up 0.2% in April from March, but after adjusting for inflation were flat, government data show.
Many people are resorting to more conventional means of borrowing: In March, consumers had a record $957 billion of credit-card and other types of revolving debt outstanding -- up about 8% from a year earlier, according to preliminary data from the Federal Reserve.
But businesses are reporting greater demand for newer cash-raising techniques. Reverse mortgages are gaining new favor. Secured by a home's equity, this vehicle can provide consumers with a lump-sum payout, a line of credit, periodic payments or a combination thereof.
Also flourishing: niche products that quickly unlock the value of a particular asset. Life settlements, once marketed mainly to the wealthy, have grown in popularity as companies target smaller policies, like Ms. Brunner's. A number of companies cater to people who've won personal-injury settlements -- which are often paid over a period of years -- by buying them out up front, typically for a sum much lower than the amount of the payments sold. Reserve Solutions Inc. of New York offers debit cards to help workers access funds from preapproved 401(k) loans.
Costly Solutions
Though seemingly convenient, each of these fast-money options 'is an expensive way to tap cash,' says Tom Orecchio, chair of the National Association of Personal Financial Advisors. 'You don't want to do these things unless you absolutely have to.'
In life-settlement transactions, sellers like Ms. Brunner often receive only about 20% of their policy's face value. People who sell the rights to their legal-settlement payments often forfeit much of those payments' value.
Ken Murray, chief marketing officer at J.G. Wentworth, the company that had the life-settlement agreement with Ms. Brunner, says that in many cases, it may be wiser for consumers to do a transaction like a life settlement rather than 'incur additional debt in order to finance what you need to do.'
While 401(k) loans generally carry reasonable interest rates, individuals who take them lose some of the valuable power of compounded returns -- jeopardizing their retirement security in the process.
Reverse mortgages often involve high fees and costs, which often add up to as much as 5% or 6% of the home value. A homeowner or his heirs must typically sell the house to repay the loan, which becomes due when the borrower leaves the home for more than one year or dies. So an owner who becomes incapacitated and needs an assisted-living facility for more than 12 months could face a huge balance due immediately.
Despite the risks, business in the fast-cash lane has been accelerating. In 2007, 18% of workers had taken a retirement-plan loan within the past year, up from 11% in 2006, says a recent survey by Transamerica Center for Retirement Studies. The number of federally insured reverse mortgages is also ticking up. From January through April of this year, lenders originated 40,068 such loans, compared with 37,020 in the same period last year.
The Financial Industry Regulatory Authority recently issued investor alerts warning consumers about the high costs of reverse mortgages and the opacity of the life-settlement market. More broadly, it also cautioned that some cash-now transactions could hurt consumers' ability to qualify for certain benefits, like Medicaid. A lump-sum payment from a life settlement or reverse mortgage could leave an individual with too much cash to be eligible for such programs.
The costs of reverse mortgages 'are all very straightforward and upfront and disclosed,' says Peter Bell, president of the National Reverse Mortgage Lenders Association. Doug Head, executive director of the Life Insurance Settlement Association, says the life-settlement industry is 'pretty good at disclosures,' but notes that regulations pending in a number of states will help improve information for consumers.
Robert Hamzey, a California real-estate agent and financial planner, has been brokering life settlements for years. But last year, as the housing market soured, he started promoting them as a way for his real-estate clients to fund a down payment. 'You can't believe how elated these people are when you find an asset that they didn't know existed,' he says.
The current environment differs from past downturns. During the last recession, home prices were still rising, many consumers could borrow against their home equity, and credit was more widely available. Now, 'real spending is hardly growing, and that's something we haven't seen since the early '90s recession,' says Scott Hoyt, senior director of consumer economics for Moody's Economy.com.
Tempting Options
Because they often have plenty of equity in their homes, but lack sufficient income for everyday expenses, older Americans are finding products like reverse mortgages especially tempting.
Daniel Petelin, 62, lives in a roughly $1.8 million house in Redwood City, Calif. His mortgage debt on the place, about $16,000, is minimal. But the freelance public-relations and event manager, who has an income of about $47,000, is still feeling pinched. 'Eggs a few months ago were 79 cents a dozen. Now they're $1.79.' With gas in his area about $4 a gallon, he's planning car trips carefully. He has cut back on eating out. And next year, his health-insurance premiums are going up to about $600 a month.
Single with no children, Mr. Petelin doesn't want to sell the four-bedroom house where his parents lived for nearly 70 years. He's not interested in a home-equity loan, as he doesn't like the idea of making monthly payments. Instead, he's planning to take out a reverse mortgage backed by the equity in his home.
He has shopped around with a few lenders, but has yet to take out the loan because in the midst of the credit crunch, he's found some banks hesitant to lend the amount he's seeking -- roughly $580,000. Still, he intends to take a loan in the near future because he says he needs the cash.
The so-called REX Agreement, launched last year by REX & Co., a San Francisco real-estate investment company, offers a different strategy. Not technically a loan, it gives homeowners a cash payment, typically about 13% of the home's value. Upon a sale of the home -- or the owners' death -- the company pockets as much as 50% of any change in home value during the time the agreement was in force. To qualify, applicants need not have much equity in their home. The minimum is 25%.
Such an arrangement sounded good to Tom Terrill, 75, of Kenilworth, Ill. After being diagnosed with an autoimmune disease in 2001, he didn't expect to live more than a few years. So, he stopped working and began focusing on enjoying life.
But after receiving a lung transplant in 2005, the retired financial-services executive now has a longer life expectancy -- and a rising cost of living that exceeds his Social Security and investment income.
'I needed to do something to get more cash or reduce my expenses or live in a very, very much downsized [home],' he says. In May, he signed a REX Agreement and received about $406,000 in exchange for 50% of any future change in the value of his $3 million home.
Some financial planners are skeptical of such newfangled products. A home can be a valuable buffer against unexpected expenses, and if owners are 'taking future appreciation and selling it and using the money now, what are they going to do in the future?' asks Jon Beyrer, a fee-only financial planner in Solana Beach, Calif. He would look at a transaction like the REX Agreement only 'as a last resort,' he says.
Tjarko Leifer, managing director for marketing and strategy at REX & Co., maintains that with a REX agreement, homeowners 'continue to participate substantially in the future change in value of the property, and the equity you have built up in your home is not eroding over time,' as it can with a reverse mortgage, says. In a reverse mortgage, the rising debt level can gradually consume all of a homeowner's equity, but this won't happen with a REX Agreement.
Even the most financially-savvy consumers are breaking some time-honed rules. Paul Herman, 51, is an attorney who represents consumers with debt and credit issues. He recently started a new law practice and went through a divorce. At the same time, his Boca Raton, Fla., house sat on the market for months without selling. With money getting tight, he went to his bank to investigate a business loan. But 'with the rates I'd have to pay, it wasn't worth it,' he says.
He tapped into his retirement savings instead, taking one loan and one taxable withdrawal. His logic: 'Why plan for retirement if you can't make it today?'
Eleanor Laise
2008-06-03
