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Wednesday, September 22, 2021

Is a Reverse Mortgage for You?

Reverse mortgages are not what they used to be. You may be surprised to learn how one could benefit you.

If you still think reverse mortgages should always be avoided, you haven’t kept up to date. These financial instruments have a variety of uses, including shouldering the weight of providing income when a portfolio has a bad year. That’s right: the optimal use of a reverse mortgage is likely not as an instrument of last resort. But let’s look at what they are and what they have to offer.

Reverse mortgages take equity that is in your home and convert it to payments to you. You don’t have to pay back the money while you live in the home, as long as you keep it in good repair, pay HOA and utilities, and maintain home insurance. This money is not taxable and won’t affect Social Security or Medicare benefits. 

There are three types of reverse mortgages:
  • Home Equity Conversion Mortgage (HECM). Federally insured and backed by the U.S. Department of Housing and Urban Development (HUD), these are the most common and can be used for any purpose. 
  • Single-Purpose. These are the least expensive and not available everywhere. The lender specifies how it will be used, such as to pay for repairs or property taxes.
  • Proprietary. These private loans are backed by the companies that develop them. They enable borrowers with higher appraised home values to qualify for more funds. 

For our purposes, we will continue by discussing HECMs.

How much you can borrow depends on:
  • Your age. The older you are, the more you can borrow — but you must be at least 62.
  • The appraised value of your home. The higher the appraised value, the more you can borrow.
  • Current interest rates
  • A financial assessment. This looks at your willingness and ability to pay property taxes and homeowners insurance. 
  • How much you owe. The greater the equity, the more you can borrow.

What you should know:
  • There are fees and costs. These vary by lender and it’s important to shop around. Generally, for HECMs, lenders charge an origination fee, closing costs, servicing fees for the life of the mortgage, and mortgage insurance premiums.
  • You will owe more as time goes on. Interest is added to your balance each month.
  • Interest rates may change. Most reverse mortgages have variable rates tied to a financial index. HECMs may offer fixed rates, but often require taking the money as a lump sum at closing. 
  • Interest is not tax deductible annually. Interest is only deductible when the loan is paid off, whether partially or in full. 
  • You must pay costs related to your home. You keep the title to your home, and you are responsible for property taxes, insurance, utilities, fuel, maintenance, etc. Otherwise, the lender can require you to repay your loan.
  • Your spouse might be able to continue living in the home. If your spouse did not sign HECM paperwork, he or she may continue to live in the house after you die if he or she pays taxes and insurance and maintains the property. But your spouse will not get any payments since he or she was not on the loan.
  • You can live in a nursing facility for 12 consecutive months before the loan must be repaid. With HECMs, the borrower can usually live in a nursing center or medical facility for 12 months before the loan must be repaid. The home must be maintained during this period, and taxes and insurance paid.
  • You can’t owe more than the lesser of the loan value or the value of the property. A HECM is a non-recourse loan. The borrower or his/her estate will never owe more than the property is worth, and no assets other than the home must be used to repay the debt. 

Learn more about reverse mortgages at the Federal Trade Commission’s Consumer Information site. If you take one out, be sure to include it as part of your estate plan and let your heir(s) know about its existence. Reverse mortgages can be costly. Costs vary by lender and it’s very important to shop around. Do your homework. Start by reading the “Shopping for a Reverse Loan” section at the Consumer Information site linked at the beginning of this paragraph. If you are considering a reverse mortgage, run the idea by your financial advisor. She/he may be able to recommend a different product, such as a home equity line of credit (HELOC) or other solution in some circumstances. 

Grow Your Retirement Nest Egg With a Reverse Mortgage

In the age of low interest rates, many retirees are electing to keep paying a 3-4% mortgage so the money can be put to work in the markets, which earn about 7% after inflation, on average. Seems like a good strategy, right? 

But it’s not without risk. What if markets drop or produce low returns for a time? And those ongoing payments create a sequence of return risk to the new retiree who must pull the money out of the portfolio month after month, year after year. 

Retirees might do better to consider a reverse mortgage instead. There is no obligation to take money in good times, and it can help retirees in bad markets by providing living expenses so they don’t have to touch investments. Read about this strategy here

There are more good reasons to open a reverse mortgage early on. Financial guru Wade Pfau, who developed the course Fitting Home Equity into a Retirement Income Strategy outlines them here. He argues that using a reverse mortgage as a last resort (a common occurrence) offers the least probability of success as part of an overall portfolio strategy to make money last through retirement. Pfau demonstrates that HECMs can be beneficial to the middle class/middle income market as well as wealthier individuals. In fact, the benefits are increasingly greater when the equity in the home is close to the value of the portfolio. 

Quick Tip: People with no children can take out a reverse mortgage so the house doesn’t sit idle when they move out or die, since the house would revert back to the lender.