The “House Rich” Can Pay for Local Services

Adam Seitchik

October 2003

Now that the Republicans are having their way with us, glibly selling tax cuts for the rich as middle-class tax relief, the nation’s finances have gone down the toilet.  The mammoth federal deficit trickles down as cuts in state block grants, leading to fiscal starvation at the local level.  So in my little town we are laying off teachers and police, closing fire stations and reducing hours at the library.

Some of you patriotic centrists out there might reasonably ask: why not plug the hole with local revenues, as an offset to the federal tax cuts?  The argument against raising local property taxes is that seniors and others on a fixed income cannot afford a tax increase on their wealth.  Bull hockey.  My mom (a child of the 1930s depression) used to warn about being “house poor,” burdened by onerous mortgage payments despite having a nice income.  Many seniors these days have the opposite “problem”: they are house rich.  Homes selling today in the Boston area for over $400,000 were trading for less than $40,000 in the mid-1970s.  Even after adjusting for inflation and the changing mix of properties, house prices have tripled in the last thirty years.  Many seniors now enjoy huge housing wealth, often with little or no debt, but receive only a modest, fixed income from social security and pensions.

It is time to stop feeling sorry for these people.  They are RICH, and they can enjoy the fruits of their riches quite easily by borrowing against their wealth.  Take a 70-year-old retiree who in the full flower of youth risked it all on a $30,000 house, dutifully paid off the mortgage, and now owns a $500,000 asset with no debt.  Many a mortgage broker would love to lend this pensioner $100,000 for 30 years at 6%.

You might wonder why a lender would offer a large long-term loan to someone with little income and a relatively short remaining life span.  Ah but remember, the borrower is rich.  First, the retiree can easily make the monthly mortgage payment of $600, now that his borrowed $100,000 is deposited in the bank.  Second, if he or his estate defaults on the mortgage, the lender now owns a $500,000 property.  Housing prices would have to decline by more than 80% for the investment to be at risk, which seems unlikely even under the policies of the Bush administration.

So what has this to do with funding local services?  Our house-rich pensioner now has plenty of ready cash, and can easily afford an increase in property taxes.  For example, pretend he lives in my wealthy Boston suburb, paying the average real estate tax bill of about $5,000 per year.  In a flight of fancy, let’s say the citizenry agree to offset Federal tax cuts with a whopping 20% hike in property taxes, or $1,000 per year.  From now until 2011 (near the end of what could be President Schwarzenegger’s first term in office) our rich pensioner’s $100,000 loan can finance the $600 monthly mortgage payment, plus the $1,000 annual increase in property taxes, and still have over $4,000 per year available for golf, going on cruises and spoiling the grandchildren.  And if over time property prices and taxes both rise by 20%, then our senior’s wealth has increased by $100,000, enough to pay the tax increase for the next 20 years and have an $80,000 windfall left over.

A 70-year old is now expected to live to the ripe old age of 86, on average.  So at the age of 78, after eight years of having fun and paying property taxes it will be time to…borrow some more money!  What if all of this fun allows our retiree to beat the actuarial tables, and live past the age of 86?  It’s important to do the math, but a careful borrower will be able to work their balance sheet to die with plenty of wealth, and surely no worse than broke.

If our happy retiree is feeling both healthy and lucky he might want to enter into a reverse mortgage, in which a lender sends a check each month for the rest of the borrower’s life, in return for owning the house when the rich fellow finally passes on.  This will turn out to be a good deal only if the pensioner lives longer than average, or house prices decline.  It does have the downside of the lender wishing that you were dead, which could lead to bad karma or worse, contract killings.

Having spent thirty years paying down a tiny mortgage, it stands to reason that our retiree would be reluctant to borrow hundreds of thousands of dollars.  After all, debt is slavery, right?  Wrong.  Depends on the balance sheet.  For a young person starting out with no assets, a large mortgage payment can feel like indentured servitude.  But for someone with dentures, whose assets well exceed their debt, borrowing can be a way to convert an illiquid property into cash.  The risk is that our retiree may bequeath a few thousand dollars less to the children.  Big deal.

So go ahead and raise property taxes a bit to fund the local library.  Instead of worrying about the house-rich retiree, let’s provide some help to young families starting without two nickels to rub together.  How about a property tax break for first-time homebuyers?  With progressive taxation under attack at the national level, perhaps it can find a home in our cities and towns.