Reverse mortgages are inching back as a possible option for careful borrowers.
By Erik J. Martin
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Heading into your retirement years and looking to delay tapping into Social Security, increase monthly cash flow, and diversify your retirement funds with an extra source of money?
You may want to move your real estate gearshift into reverse — a reverse mortgage, that is, which can be a financial salve to homeowners 62 and up who consider their options carefully.
A reverse mortgage is a loan that provides homeowners an advance payment on their property’s equity and delays repayment until the homeowner moves, sells the home or dies. It fell out of favor following the housing boom, when a relatively high rate of borrowers defaulted after draining the equity in their homes.
Since 2013, however, the government has enacted rules intended to protect borrowers and promote the federally insured Home Equity Conversion Mortgage (HECM) program as a financing option.
Under the guidelines, borrowers in most cases may not withdraw more than 60 percent of available funds the first year, so they do not spend too much, too soon. The borrower’s income, expenses and credit history are analyzed to ensure he or she is a worthy candidate and is able and willing to pay property taxes and home insurance. Non-borrowing spouses younger than 62 may remain in the home after the death of the borrowing spouse.
Financial advisors are more willing to consider reverse mortgages as a strategic tool for retirement income planning in certain circumstances. “They can be a saving grace for many retirees since the average American has about twice as much wealth in their homes as in their other retirement savings,” says Jamie Hopkins, professor of retirement income at The American College of Financial Services, Bryn Mawr, Pennsylvania. Among the uses Hopkins points out:
- providing a steady stream of income after retirement and up to age 70, allowing Social Security payments to be deferred until they reach their maximum level
- providing diversification as a non-market-correlated asset that generates income when market investments decline
- improving retirement cash flow by allowing a traditional mortgage to be paid off, curtailing a retiree’s monthly outflow of cash
Here are three reverse-mortgage strategies that financial advisors may suggest:
- Take a Lump Sum
Borrowing enough money to pay off the existing mortgage on a home is a common use of a reverse mortgage. “You can eliminate your monthly mortgage payments and have additional cash flow,” says Joseph P. DeMarkey, strategic business development leader for Reverse Mortgage Funding, Bloomfield. For a homeowner who can handle the ongoing costs of a home and is likely to be able to live comfortably in the space as they age, this may be a reasonable option. - Open a Line of Credit
Using an HECM loan to open a line of credit to hold in reserve, in the event of future need, is another option. Borrowers can choose when to withdraw funds to protect their savings and income during stock market fluctuations.
For example, in a bear market, when a retirement investment portfolio is down, the homeowner may borrow from the line of credit as needed. There is no need to sell investments at low prices and diminish the retirement portfolio’s power to grow in the future. When investments rebound, stock proceeds can be used to pay off the line of credit, so the full amount is again available in the future.
Any unused line of credit grows over time. “The line of credit cannot be reduced or frozen by the lender so long as the borrower meets the loan obligations, like keeping current with property taxes, insurance and maintenance,” DeMarkey says.
Regardless of which option you select, always remember that a reverse mortgage comes with risks, including the fact that interest compounds on the debt. Remember, you are paying someone else to get access to your home equity.
Closing fees and expenses vary depending on the type of reverse mortgage you choose. Shop for the best deal and pay attention to the total cost.
Lock down your plan for paying property taxes and insurance premiums, which are required. If you default on these payments, the lender can foreclose on the reverse mortgage and you could be forced to move.
As with any loan, a reverse mortgage eventually needs to be paid back. Normally, this is deferred until the death of the last remaining borrower.
Any remaining equity in the home after a sale remains with the homeowner or estate.
To learn more about reverse mortgages, search for and download the guide, “Considering a Reverse Mortgage?” from the Consumer Financial Protection Bureau, consumerfinance.gov.
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