Easy Money or Bad Idea?

A number one concern of retirees is running out of money in retirement. Say you’re strapped for cash flow, or worried about depleting your retirement savings. What do you do?

Home equity might be your most significant asset and a tempting solution. Early on, I was drilled “Don’t consider your residence as an investment asset. It’s a personal asset – you need a roof over your head. Consider it an ‘idle’ asset. Accessing that equity is via selling the home, or borrowing against it.” The first one – downsizing – may make sense for retirees (less lawn to mow). The second one… well we learned the harsh lessons of using our homes as ATMs. But a third option emerged – reverse mortgages.

Easy money? Perhaps. They offer homeowners the benefits of staying in their home, and, withdrawing some of the equity. But their popularity suggests otherwise. HUD’s reverse mortgages (Home Equity Conversion Mortgages or HECMs) number about 60,000 in the US in late 2013, representing a decline of almost half from their high in 2008-09. Some call reverse mortgages “loans of last resort.”

There are many types of reverse mortgages including those government or agency backed, and proprietary or privately insured. We’ll focus on FHA-insured HECMs.

I’ll summarize what they are, and more importantly, several planning considerations which are relevant to other issues in your personal finances.

They’re a type of home loan where homeowners convert a portion of the equity into cash – a lump sum, line of credit, monthly cash payment, or some combination. But you don’t make payments. There are many requirements, variations and loan calculators which you can read online (e.g. HUD.gov). Generally you must be 62 or older, the homeowner, and live in the home. The accessible cash is based on age, interest rates, and property value. Per a hypothetical estimate on ReverseMortgage.org, a couple age 65 with a $300,000 home debt free might qualify for a monthly check of about $847 for life, or a principal limit of about $153,000. Homeowner retains title to the property, and the responsibilities of taxes, insurance, utilities and maintenance. Mirroring traditional mortgages, these generally involve rising debt (mortgage balance) and falling equity. The loan generally comes due when you sell the home, move out, or the surviving borrower passes. And mortgage insurance helps protect the borrower.

Planning Considerations

Know the costs – Reverse mortgages are generally more expensive than traditional mortgages – both up front and on-going – primarily due to the cost of mortgage insurance and servicing fees. Read and understand the documents.

Inflation – Two impacts. First, perhaps you’re procrastinating – “We’ll downsize or reverse mortgage later.” Higher inflation implies higher interest rates. If you’re going to downsize and finance part of the purchase, why not make the transition before mortgage rates significantly rise? And, if you’re going to reverse mortgage, higher rates may mean a lower amount of accessible cash. Second, inflation can decimate the value of electing a lifetime of fixed payments. Using the example above, if you reversed today, an $847 monthly check may be sufficient to augment your retirement income today. Will that same $847 check be enough in 20 or 30 years?

Non-borrowing spouse – What if you’ve remarried… the pool boy (or gal) – i.e. you were 62 or older and qualified for the HELC, but not your partner – or your partner wasn’t listed on the title (or didn’t want to sign the loan papers)? And what if you died? He or she likely needs to find another roof, and the reverse monthly checks cease. Spousal protection cases are currently in the courts. What steps should you do today in planning for the future?

A piece of pyrite sits in my office. It’s heavy, multi-faceted and shiny. As “fool’s gold,” it’s a reminder to me that things aren’t always what they appear to be. Talk to your advisors. Get legal counsel. Think things through.

About Brian Loy

Brian Loy writes insightful and inspiring articles about the ever-changing world of personal finance and the global trends that affect the risk and return on investments and shape the financial- and retirement-planning process.
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