Reverse mortgages are a controversial product. Their interest, fees and mortgage insurance consume a lot of the borrower’s home equity. They don’t let homeowners access as much home equity as they could by selling and downsizing. They make it more difficult to leave the home to heirs. They’re much harder to understand than traditional forward mortgages. They’ve caused surviving spouses to lose their homes unexpectedly. Scammy home contractors and investment advisors have used them to steal seniors’ money. One of the nation’s biggest reverse mortgage lenders is under investigation for insurance fraud.
The Right Circumstances
All that said, reverse mortgages, which usually come in the form of federally insured home-equity-conversion mortgages (HECMs), can be the right option for the right people in the right circumstances. The right people are financially sophisticated enough to understand the different types of reverse mortgages—their terms, conditions and costs. If you can’t understand these on your own but can get a grasp on them with the help of a trusted financial planner who doesn’t stand to make money off your decision to get a reverse mortgage, then that works too.
The right circumstances include not being particularly concerned about leaving your home to your kids or other heirs; having a substantial amount, if not all, of your first mortgage paid off; wanting to remain in your home for the rest of your life (and having a home that can accommodate the aging process), and needing a supplemental or backup source of retirement income.
Creating a More Financially Comfortable Retirement
There are several ways to receive the proceeds from a reverse mortgage. Choosing the credit line version of the HECM early in retirement, then using funds in some years but not in others to supplement retirement portfolio income, could give retirees the best odds of having a comfortable cash flow during retirement while ensuring they don’t run out of money before they die, according to retirement researchers Barry Sacks and Stephen Sacks.
Their recommendation for a “coordinated strategy” goes against the conventional wisdom of using a reverse mortgage only as a last resort, when a retirement portfolio becomes drained prematurely. And the authors don’t argue that all retirees should take out a reverse mortgage, only that the coordinated strategy is the most successful for those who need more income than their portfolio’s safe withdrawal rate can provide to live comfortably in retirement.
A reverse mortgage line of credit lets the homeowner decide when to borrow and how much to borrow; there’s no requirement to borrow a certain amount at any point. In other words, they can customize withdrawals based on their changing needs and only pay interest when they actually need to borrow. The unused portion of the line of credit grows over time—and the lender can’t decide to revoke the line of credit if the home’s value decreases or the homeowner’s credit score plummets—two safeguards that regular home-equity lines don’t offer.
Also, unlike a home-equity line, the money borrowed through a reverse mortgage doesn’t have to be repaid during the senior’s lifetime. It can be repaid from the home’s equity after the last borrower passes away (or moves away).
Help for the Financially Unprepared
What about homeowners who aren’t financially prepared for retirement? They, too, might benefit from using a reverse mortgage to fund their retirement needs, but they’ll want to use a different strategy than the homeowner who is using a reverse mortgage to supplement retirement portfolio income.
Eighty percent of households over age 62 own homes, and home equity is the primary source of wealth for more than half of seniors, report researcher Stephanie Moulton and her colleagues at Ohio State University. The most common reasons why seniors took out reverse mortgages from 2009 to 2011 were to increase their monthly income and/or to pay off an existing mortgage. Paying off other debts was another significant reason. In the group analyzed, more than one-third had medical debt, 16 percent had a revolving account past due and 18 percent had a mortgage past due.
For these homeowners, using a lump-sum reverse mortgage to pay off the existing mortgage can provide greater financial security by eliminating the monthly mortgage payment and reducing the risk of foreclosure. The biggest problem with this loan option is the risk of mismanaging the remaining proceeds and running out of cash. With no home equity and no money in the bank, that senior becomes dependent on family, friends and public services to afford even the basics.
A financial advisor can help seniors in this situation determine whether they’re using a reverse mortgage to fund a lifestyle they really can’t afford. Perhaps selling and downsizing would be the wiser option. Also remember: Homeowners must be able to continue to afford property taxes, homeowner’s insurance and home maintenance, or the reverse mortgage lender can foreclose.
Likewise, using a reverse mortgage to afford medical bills can be shortsighted. A reverse mortgage requires borrowers to continue occupying the home as their primary residence. If they move out for any reason, including a medical reason, the reverse mortgage must be repaid. All the same—because reverse mortgage income is tax free and borrowers don’t need a good credit score to qualify—they can be a great last resort for someone who is in a last-resort situation.
A Valuable Tool
Using a reverse mortgage to tap home-equity wealth can make retirement more comfortable for seniors who want to age in place and can understand how the product works and use it responsibly. Whether it’s to supplement the income in a retirement portfolio or pay off a first mortgage to improve retirement cash flow, a reverse mortgage can be a valuable tool for funding retirement.