Reverse mortgages have been thought of as the “hand me down” financial alternative if there was nowhere else to go. Second tier actors hawk them on TV. Expenses have been excessive in the past. Typically the only people looking into them were those who couldn’t find another way to stay in their homes.
But that’s changed in the past few years.
Now well-respected financial planners are considering them for even the highest net worth investors. The most popular financial planning software packages are including them as a main stream option to consider in retirement planning. Financial journals feature studies looking at how and when to use reverse mortgages.
So what do you need to know to make an intelligent decision about whether to include a reverse mortgage in your retirement strategy?
Reverse mortgages give people age 62 and older an opportunity to tap into 60% of their home equity up to a maximum loan of $765,600. Borrowers don’t need to pay back the loan until the home is sold or the homeowner dies. Interest accrues against the loan balance. You do have to be able to pay the real estate taxes and insurance on the home, or you’ll be in default.
Mortgage interest is deductible, but only when paid. So there can be a big mortgage interest deduction when the house is sold and the loan (and interest) repaid.
Reverse mortgages are insured and regulated by the Federal Housing Authority (FHA)/U.S. Department of Housing and Urban Development (HUD). So the difference from one company to another offering these loans are typically closing costs and origination fees. It pays to compare.
A home equity conversion mortgage (HECM), commonly known as a reverse mortgage, has an increasing line of credit. When you take out a reverse mortgage you can set up a line of credit to use in the future, set up monthly payments to yourself or a combination of both. The sooner you take out the loan, the more it can grow over time. This is unlike a traditional line of credit or mortgage.
You don’t have to repay a reverse mortgage, although you can if you like. You can’t have a reverse mortgage and a traditional mortgage at the same time. But you can refinance your traditional mortgage into a reverse mortgage if you meet the criteria. This may stop the stress of having to meet large monthly cash outflows that are part of a traditional mortgage. You can also use a reverse mortgage to finance a downsized home purchase. This only works with principal residences.
What happens if you go into a nursing home? This would count as a “triggering event” (like death or moving), but you have up to one year to come out of the nursing home (or rehab center) and go back into your home.
Why Would You Want a Reverse Mortgage?
- Probably the most discussed aspect of having a reverse mortgage is as a technique to address “sequence of withdrawal” risk. This risk highlights the vulnerability of someone in the early stages of retirement who experiences a significant drop in the stock market. It is much harder to recover from a set-back early in retirement than later. A reverse mortgage allows the investor to temporarily tap their home equity instead of drawing from their portfolio while it is down. This may be preferable to holding a larger cash reserve.
- Low interest rates make this strategy more attractive. That’s because lower interest rates impact the cost of putting the reverse mortgage in place. This is not an inexpensive process.But it does allow for more flexibility in protecting principal from stock market vagaries.
- Some high net worth seniors are using the reverse mortgage as a way to pay for home health care. Many people prefer to stay in their homes for as long as possible. This is also true for those seniors who are “house rich” and “asset poor.” Tapping the equity of the home may allow them to “age in place” longer.
- Reverse mortgages are non-recourse loans. So if the value of the house is eventually less than the loan, you or your heirs are not responsible for the difference. This is akin to owning a “put option” on your home. If the home appreciates, you get the profit when sold.
- Since you don’t have to repay the reverse mortgage (until the house is sold or you die), it can act as a type of “longevity insurance.” You can tap into the equity of the home to meet expenses. But don’t wait too long to get this type of loan in place.
- Some retirees choose to use a reverse mortgage so that they can defer taking SocialSecurity benefits until later. That may allow higher benefits over time. They can tap a reverse line of credit or set up monthly payments for cash flow before Social Security kicks in.
- A bank home equity line of credit can be frozen or cancelled. Not so with a reverse mortgage.
- The older you are, the more you are eligible to receive through your loan.
Why Wouldn’t You Want a Reverse Mortgage?
- This is not an inexpensive strategy. Costs include appraisal, origination, title search, insurance, inspections, recording, taxes, credit checks and an up-front mortgage insurance premium of 0.5%. Most fees can be financed as part of the reverse mortgage, but they reduce the amount that can be borrowed. There can be an ongoing service fee, but you maybe able to get that waived.
- You need to have lived in the home for at least five years or the fees can be prohibitive. It may make more sense to sell the home and downsize or perhaps even rent.
- It doesn’t make financial sense to take out a reverse mortgage if you only plan to stay in the home a few years.
- The interest on the loan compounds. Since you don’t have to make monthly payments, what you eventually have to pay is the principal borrowed plus interest plus interest on the interest over time. So if you have this loan over a long period, the interest charges can really add up. You can make payments against the interest however; and that could help keep interest costs down. There are no pre-payment penalties.
- Once the last remaining borrower has died, the FHA will move quickly to recoup its investment. A letter will be sent out stating the loan balance is due. Whoever is settling the estate has 30 days to respond to whether the home will be sold or the loan will be repaid. If you don’t respond in time, foreclosure proceedings may be started. If a timely response is made, then extensions of up to one year can be granted.
- When the house is eventually sold, if there are significant capital gains, you might not have the money to pay the tax.
- The interest rate tied to the reverse mortgage is likely to be a variable, not a fixed, rate.That means the interest may (and probably will) go up in the future.
- If we experience higher inflation, the payments from the reverse mortgage won’t go up.
- If you use a reverse mortgage to stay in your home longer, when you do eventually sell the home the proceeds will be less because you have to repay the loan. That can limit your options for buying another home or how much you can spend on a Continuing CareRetirement Community buy-in.
- If you spend down your home equity by using a reverse mortgage, there’s less available for inheritances. You should let your kids (or heirs) know if you decide to use a reverse mortgage because it will probably be them that have to respond to the FHA within 30 days after you die or leave the home.
- Reverse mortgages are more complex loans. You’ll have to go through mandatory counseling before you take one out to make sure you understand what you’re getting into.
A reverse mortgage, like long-term care insurance, is not for everyone. But it may pay to consider it as part of your retirement strategy. There may be benefits of improving cash flow, increasing withdrawal rates, providing liquidity in times of stock market downturns and hedging against longevity or a drop in your home’s value. But that must be weighed against the costs and eventual disposition of the home and the implied consequences.
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