For a long time, commentators divided the world into
those who worked hard, avoided debt, lived frugally and boosted their
savings, and those who didn't. In the end, they claimed, those who chose the
former path would be better off.
Unfortunately, the speed and degree to which
circumstances have deteriorated over the past year have blurred the
distinction. While those who did the right thing and prepared themselves for
stormy economic weather are in a better relative position, many are
nonetheless under the gun.
In "Tapped Out: Pinched
Consumers Scramble for Cash" the Wall Street Journal's Eleanor Laise reports on a number of individuals who are suddenly
being forced to change their prudent ways in order to survive.
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
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, which 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 shares in as much as 50% of any future gain
or loss in the property's value, typically collecting proceeds when the house
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
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.
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
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.
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
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.
A Different Strategy
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
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
"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."
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?"