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Building a Nest Egg or Courting Disaster



By Stacie Zoe Berg
Special to the Washington Times

A new mortgage product to be offered in the next few months combines a 30 year mortgage loan with a life insurance policy in a tax deferred investment program that promises home buyers a windfall. Or they could lose everything.

The so-called money back mortgage loan, modeled after the British endowment mortgage common in the United Kingdom, combines a universal life insurance policy with a 30 year, fixed rate non-amortizing, interest only mortgage loan. It will be offered nationwide through Investment Mortgage Corp. of Charlotte, N.C.

The monthly payments that would be used to pay off the principal on a conventional. mortgage loan are used instead to pay the premiums on a life insurance policy. Thus, the homeowner builds no equity in a house through the payments.

In fact, to reap maximum benefit from the program, it appears a home buyer must own the house 30 years – or die.

If the homeowner dies before the loan is paid off, the property passes debt free to the heirs. But in that case, if the insurance policy is worth more than the house, the lender gets the profit.

Meanwhile, the monthly payments are higher than those of an equivalent conventional mortgage loan.

IMC presumes that the money invested in the life insurance policy over the years will exceed the principal owed, which is due in a lump sum at the end of 30 years.

IMC says investment of the insurance premiums will produce a nest egg projected to be 25 percent to 50 percent of the original loan amount.

“You’re building money faster in that life insurance policy than you otherwise would have been amortizing in your loan,” said Roger Pell, IMC executive vice president.

But look before you leap, advises Alexandria real estate lawyer Beau Brincefield.

“There are all kinds of numerical examples they give you, but all of those examples are based on certain assumptions, and there is no guarantee that those assumptions will prove to be true,” he said.

“It’s possible to construct a contract that will give a certain lump sum at the end [in Britain],” said Peter Chinloy, professor of finance and real estate at American University.

But British homeowners find they can’t afford to sell their homes when the market turns down, Mr. Chinloy added.

“Because the mortgage doesn’t amortize, what happens in Britain when the housing market declines, as it has done for a few years, is that a lot of people have negative equity. In fact, it’s relatively easy in Britain to have negative equity,” Mr. Chinloy said, which means the house is worth less than the mortgage. But the loan combination is accepted in Britain, “so Brits take it and stay where they are” rather than try to sell their homes, he said.

And there are other drawbacks to the new loan.

The loans disclosure statement says that if a borrower wants out of the deal early, he may incur a surrender charge. “Why would you surrender it early? You decide it’s a bad deal, you buy another house, you need to borrow money for college,” Mr. Brincefield said, and you could end up with nothing.

“The other risk, I would suspect, is that the IRS might disallow it,” Mr. Chinloy said.

“This is what I’d call a win-lose situation,” said Erich Prinz, a former agent at Northwestern Mutual Life in McLean, “because they [the lenders] win, regardless. They’re not taking any risk.” But if you have any difficulty, or if the insurance company investments fail, you lose, he said.

The percent of payment invested varies, but is roughly 30 percent, Mr. Pell said.

The gross monthly payment of a traditional, amortizing loan is lower than for this money back loan, Mr. Pell acknowledged.

“We look to bring the cost in alignment with the same average after tax cost as you would have with a traditional loan.

“But keep in mind we’re building in substantially more in the way of tax advantages, meaning tax deductibility of interest,” Mr. Pell said, adding, “The average after tax monthly payment is identical.”

Tax consequences are based on current tax laws, Mr. Brincefield noted, which have different effects on different taxpayers.

“Any attempt at back fitting is going to result in a deceptive insurance proposal,” said Ric Edelman, president of the Edelman Financial Center in Fairfax. “Conceptually, it’s a very interesting idea.”

But the monthly premium payments are tied to the cost of life insurance, which is tied to your health status, Mr. Edelman pointed out. “The older you are; the worse your health, the more expensive that’s going to be.”

Mr. Pell acknowledged that buyers should Plan to stay in the home at least 12 years to profit from the new loan. It doesn’t make sense for those on the move, he said. Borrowers who sell their homes will have to pay the full principal, even though they’ve been paying for years, because none of their payments was applied to the principal. But, Mr. Pell said, because of the projected increase in the value of the life insurance policy, borrowers who sell should break even “at the fourth year.”

The loan is too new to know if it will work as promised, Mr. Edelman and Mr. Brincefield said.

“I would not recommend any consumer sign up for this until after there’s independent evaluation provided by the financial planning, accounting, legal and mortgage banking professions,” Mr. Edelman said. He said the disclosure document does not provide complete and full information but is more of a disclaimer. “It is very difficult to analyze because it is so subject to change and variation,” Mr. Brincefield said. The program is untested in this country and there is no history to go by, he said.

“There are future events that will affect your investment, and you can’t predict those future events. And depending on what those future events are, this could be a great deal or it could be a disaster for you,” Mr. Brincefield said.

“Depending upon the assumptions you make, any investment program looks like a gold mine,” he said. “But this thing is so complicated and is so subject to future events that there’s no way of knowing whether it’s going to be good or bad until it’s over and done with, and then [if it’s been bad] it’s too late.”

With conventional fixed rate loans, the more the borrower pays the more the principal is reduced. The monthly payments remain the same. But with the new “money back” loan, the disclosure statement reveals that the monthly payment may be increased “and you don’t know when or by how much,” Mr. Brincefield noted. “It says that the insurance carrier may default on your policy. It says that at the maturity of the loan the cash surrender value of the insurance policy may be less than the amount you owe on the loan.

“If there was ever a situation where somebody was invited to buy a pig in a poke, this is it,” he said.

Reprinted from The Washington Times, Friday, February 7, 1997.

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