Should You Use A Reverse Mortgage in Retirement?
Over the years, reverse mortgages have been viewed with suspicion by most financial professionals. They’ve often been viewed as “as-seen-on TV” products, much like minted gold coins being advertised as a safe alternative to traditional investments – something that a salesman is trying to sell you to make a quick commission. Like most financial products, they are not a universal solution that fits everyone’s needs. Rather, in the right circumstance, a reverse mortgage can be a useful component of a well-rounded retirement plan.
What are they?
In the U.S., there is over $13.35 trillion dollars in home equity – which is a lot of money in real property! The concept of pulling equity out of the home is so popular to seniors who want to supplement their income that the Department of Housing and Urban Development (HUD) facilitates the product by insuring Home Equity Conversion Mortgages (HECM), which are available through FHA (Federal Housing Administration)-approved lenders.
A reverse mortgage is a way to withdraw part of the equity in your home over a certain period of time. You offer up your home equity as collateral, and in return, receive a monthly or lump sum paycheck that acts as a loan. When the house is no longer your full-time residence (or if you fail to meet the obligations of the loan), then you or your heirs have several options:
Write a check and pay off the loan
Purchase the property for 95% of its current appraised value even if the loan balance is more than that
Allow the lender to sell the home
Sell the house & pay off the loan with the proceeds
Similar to having a traditional mortgage, you still own your home with a reverse mortgage. You must continue to pay property taxes and make necessary repairs to keep it in good condition. It’s also worth noting that a reverse mortgage is a non-recourse loan. If your home sells for less than the amount of equity that you borrowed, then the bank can’t come after you for the difference. As you will see, you do pay a premium to have the non-recourse, but it is a valuable component of the product.
Why use a reverse mortgage?
If you have a traditional mortgage that extends into your retirement, but already have a significant amount of equity in your home, leveraging a reverse mortgage to pay off your traditional mortgage may make sense. It essentially delays your mortgage payment until you decide to move out of your home. This is especially helpful if it lowers or allows you to delay making withdrawals from your portfolio, allowing continued growth throughout retirement.
The second best use for a reverse mortgage is to open a line of credit or receive fixed monthly payments. Opening a line of credit allows you to pull from your equity as needed. In a down market, rather than selling securities at a loss, you could pull funds from the line of credit as you need them, while allowing your portfolio to recover. Receiving fixed monthly payments provides a steady stream of income, regardless of what is happening in the market.
When does it make sense to use a reverse mortgage?
A reverse mortgage can be a useful under certain conditions:
You have significant equity in the home.
You are okay with selling the home at some point in the future – it won’t be left to your heirs.
You plan to stay in your home for a majority of your retirement.
You have a plan to fund housing after selling your home – remember, most or all of the sale proceeds will return to the lender!
How do I qualify?
If a reverse mortgage sounds right for you, there are a few requirements to consider:
You and your spouse must be older than 62.
The home must be your primary residence, and you will continue to live there.
You have a single family home or 2-4 unit apartment/condominium.
The maximum amount of equity you can leverage is $679,650 in 2018.
You cannot have any liens on the property. All mortgages and HELOCs must be paid off. However, you can use the reverse mortgage to pay off a current mortgage or HELOC, if you have enough equity in your home to do so.
What are the costs?
The upfront costs of a reverse mortgage can be significant, but change depending on the amount of equity you withdraw from your home, and how much the lender charges for the loan.
To give a quick example, let’s say a 65 year old couple withdraws $500,000 of equity from their home in the form of a reverse mortgage. They could receive a lump sum payment of about $258,000 or $1,771 per month for 20 years. The upfront costs would look something like the following:
Loan Origination Fee: $6,000
This fee is charged by the lender for offering you the loan. This fee cannot exceed $6,000, capped by the government, but may be less than that amount depending on your lender. Let’s assume it is the maximum amount here.
Initial Mortgage Insurance Premium: $10,000
When applying for a reverse mortgage, you are required to have mortgage insurance in the event that the value of your home depreciates below the loan balance. If that’s the case, you wouldn’t pay anything, but the mortgage insurance reimburses the lender. The insurance premium is built into the reverse mortgage, and will affect the monthly or lump sum amount that you receive. However, an initial premium of 2% of the amount withdrawn is charged.
Other Closing Costs (titling, appraisal, etc.): $3,000
Total Upfront Cost: $19,000
Reverse mortgages are complicated products, but if used carefully they can be incorporated as part of an overall efficient retirement income plan.
Remember, these products aren’t for everyone! Consider the following:
When do I plan to move out of my home?
Can I afford a new home without the proceeds from selling this home?
Do I want to leave this home to my heirs?
We strive to educate our clients on all financial solutions available to them, and will work with you to design a retirement plan that best fits your needs. Please give us a call if you would like to discuss how a reverse mortgage may or may not fit into your specific plan.
*Payments based on a 2.78% 10-Year LIBOR Swap Rate and 2.25% lender’s margin.
- Presented by Jack Lowe, CFP®