If most of your wealth is tied up in your home, does it make sense to tap that wealth in retirement via a reverse mortgage?
A reverse mortgage is a type of loan available only to those aged 62 or above. It converts a portion of the equity in your home into cash payments or a line of credit, which can supplement retirement income while you continue to live in your own home. Loan repayment doesn’t occur until the owner moves out of the house, sells the house, or passes away.
It’s important to note that reverse mortgages today aren’t the same product as in pre-financial crisis days when they had a pretty shady reputation. Then, reverse mortgages were expensive products hawked by aggressive salespeople -- often to those experiencing financial hardship. Those characteristics combined with awful stories about people being forced out of their home under duress helped them to earn their unsavory image.
But things have since changed. The federally insured Home Equity Conversion Mortgage (HECM) program significantly lowered reverse mortgage costs, and the Reverse Mortgage Stabilization Act of 2013 also beefed up consumer protections. As a result, reverse mortgages are getting a second look these days as a serious retirement planning tool.
Reverse mortgages can work for retirees at a range of wealth levels by providing a source of liquidity in down markets, when retirees may be reluctant to draw on their IRA or other retirement accounts. Tapping the equity in one’s home in down markets can give investment accounts more time to rebuild. That makes reverse mortgages one way to lower the risk of outliving one’s savings.
Retirement expert Wade Pfau has recommended applying for a reverse mortgage line of credit as soon as individuals reach the required age of 62. The line of credit grows each year regardless of the value of the house, and interest accrues monthly only on the amount borrowed -- not on unused lines of credit. In addition to serving as a hedge against down markets, that line of credit could be used as a deferred annuity or long term care insurance, where one uses the home as collateral instead of paying insurance premiums.
Reverse mortgages may come up for discussion more often in today’s low interest rate environment. But of course, they must be used responsibly. They still are loans backed by what is often an individual’s largest single investment.
Some important things to know about reverse mortgages include the following:
In addition to being 62 or older, you must own your home outright or have a very low mortgage balance. If you do still hold a mortgage, funds from the reverse mortgage will be used to pay off your existing mortgage first. Reverse mortgage fees have been reduced significantly. Closing costs are about the same as a traditional mortgage.
Any distributions from your reverse mortgage will be tax free. And again, the loan does not have to be repaid until the last borrower sells the house, moves out, or dies. The borrower will never owe more than the value of the home, even if the home value drops below the loan amount, because it is a nonrecourse loan. And thanks to the Reverse Mortgage Stabilization Act of 2013, a spouse who was too young to be a co-borrower can still stay in the house after an older spouse dies – but he or she will not be able to borrow more money.
The Home Equity Conversion Mortgage program limits the amount you can borrow based on your age, interest rates, and the amount of equity in your home. Currently, you can access about half the home’s value up to a limit of $625,500.
You must maintain your home and keep up the property taxes and homeowner’s insurance for the loan to remain in force. And of course, it’s always important to keep in mind that no single product ever fits every situation. Still, reverse mortgages are now a viable part of the tool belt when it comes to looking for retirement planning solutions.