Recently a leading academic voice on Retirement Security, Alicia Munnell, of Boston College’s Center for Retirement Research came out and highlighted 3 Keys to fixing the retirement crisis:
- Work longer
- Shore up Social Security
- Leverage Home Equity
This article illustrates how using mortgage debt and home equity strategically can be a smart choice for people who plan ahead, since it can give you more flexibility and enable other strategies to maximize your net worth, retirement income and quality of life.
No one can see into the future, so it is good to give yourself options.
If you’re like me you bought your first home when you had a young family and you wanted to provide a home for them in a good community with great schools. You also probably used a mortgage, so you could buy your home when you needed it – since almost no one buys their first home for cash. The mortgage allowed you to get what you wanted (your home) – when it was most valuable and useful to you. Perhaps you even set up a Home Equity Line of Credit (HELOC) so that you’d have even more flexibility to improve your home when it mattered – ex. if you needed an extra bedroom for your children. It was a strategic decision to use a mortgage (debt) and even though you paid a lot in interest – for most people it paid off and they built a sizable amount of home equity over the years.
Basically most people make a long term strategic decision to use a mortgage to achieve the American dream; to buy a nice home for their family and start to build home equity for the future.
If you’re like most people facing retirement you’re thinking hard about how to generate enough income in retirement and feel confident that it will last as long as you need it to. On our site we see a lot of people coming through who are considering how to use their hard earned home equity most wisely, since for many it’s the biggest part of their net worth. We have many visitors who are considering a Home Equity Conversion Mortgage also known as HECM or Reverse Mortgage, but thinking about it “for the future”.
People think about a Reverse Mortgage very differently than their regular mortgage – instead of thinking strategically we observe that many think tactically – in other words they wait until they have no other choices and then use their home equity as a last resort if they can.
There are many reasons that people think tactically vs strategically about how to use home equity:
- they are reluctant to use debt on their home to insure their retirement (even though they paid a lot of interest over the course of a typical 30 year mortgage)
- they don’t understand how products like reverse mortgages work (and aren’t aware of new product changes that make it safer)
- many people view using home equity is a “last resort” solution.
When people act at the last minute they often get worse deals (accepting the terms and potentially higher rates at the time) or no deal (they don’t qualify). For some people it leads to worse outcomes – they are forced to move and downsize, sell stocks or other assets at a bad time, cut expenses deeply or make other tough choices since they didn’t set themselves up with flexible enough options. Net – net many people suffer a worse quality of life than they would enjoy if they set themselves up with more options.
I’ve seen HECMs being used in my own family – my grandmother-in-law used a reverse mortgage to pay for retirement and it ended up providing flexibility when she had a health event and wanted to age in place. I’m sharing her story, because she used her home equity more strategically than most people by putting a reverse mortgage in place on her terms before she absolutely had to have it. Note: She could have also chosen to sell her home and downsize to a cheaper home, but she wanted to stay in her home for family reasons.
She and her family wanted her to continue to live in her home, so they used some of the line of credit to help subsidize in home care – which was augmented by weekly visits from her children to provide care on the weekends. Overall it was a big family effort to provide her a comfortable life and enable her to age in place. Ultimately she passed away at 94 and while the reverse mortgage balance had grown, housing prices had also recovered, so her children were able to sell the home for over the mortgage amount and still inherit some money. If they had not put the reverse mortgage in place, then they likely would have had to write checks for ~ $50,000 per year to help pay for her care for several years. This would have resulted in less interest on the home, but not all the children had the same capacity to write big checks for an indefinite amount of time to contribute financially to her care. Note: If her house price had not recovered when she passed away and it was worth less than the reverse mortgage debt amount, then they would have had the option to buy the home at 95% of the appraised value if they wanted to keep it OR return the house to the lender and FHA’s insurance fund would cover any shortfall.
Comparing the Risks and Rewards of Using a HECM Strategically
Here’s a summary of some scenarios for people who use a HECM in advance and those who don’t. Using home equity strategically and getting an HECM Line of Credit in Advance can lower your risk and lead to better outcome in the event that interest rates rise, housing prices go down and/or you have unexpected expenses due to health care or other issues.
Scenario 1 – Smooth sailing in retirement -Rates stay low and there are no unexpected expenses
- Regular mortgage: Just pay down mortgage and leave a nice estate for children
- Reverse mortgage line of credit: Just pay down Reverse Mortgage and leave a nice estate for children (You can pay down a Reverse Mortgage just like a regular mortgage – the only difference is a Reverse Mortgage will have negative Amortization if you don’t make payments.)
Scenario 2 – Unexpected expenses in retirement — Rates stay low, but there is a need for a lump sum of money
If you have a regular mortgage — or if you have paid off your mortgage — these are your risks and options:
- Get a reverse mortgage (if you qualify at that time and it can take 4-8 weeks)
- Get a HELOC (Home Equity Line of Credit) – which you need to make payments on and need enough income to qualify for
- Sell investments (risk that market is down at the time)
- Sell/downsize home
- Significantly cut expenses and lifestyle
If you have a reverse mortgage line of credit, you have more choices for optimizing your wealth. You can consider all of the options that are listed above as well as:
- Sell investments if market conditions are good
- If the markets are down, you can withdraw from your Reverse Mortgage Line of Credit and then pay it back when market comes back
- Take a lump sum out of the Reverse Mortgage line of credit (which you can pay back)
Scenario 3 – Rates rise and you have unexpected costs in retirement – Rates rise and there is a need for a lump sum of money
If you have a regular mortgage — or if you have paid off your mortgage — these are your risks and options:
- Sell investments (Although if the market is down at the time, then you may lose money.)
- Get a HELOC (Home Equity Line of Credit) – which you need to make payments on and need enough income to qualify for
- Try to qualify for a reverse mortgage (rising rates may make it more difficult to qualify)
- Sell/downsize home (Although there is a risk that housing prices are lower due to higher interest rates.)
- Significantly cut expenses and lifestyle
If you already have a reverse mortgage line of credit in place, then you have a wider array of options. You can also:
- Sell investments if market conditions are good
- If the markets are down, you can withdraw from your Reverse Mortgage Line of Credit and then pay it back when market comes back
- Take a lump sum out of the Reverse Mortgage line of credit (which you can pay back)
Plus… There is a bonus to having the reverse mortgage line of credit. If rates rise, the Line of credit should grow faster and you’ve locked in your home equity by getting this when rates were lower.
Reverse Mortgages Can Create Financial Opportunities and Options
In Summary the financial reasons for using home equity strategically (before you need it) include:
- Getting the right platform in place for your retirement – while you can qualify and when it’s a good value (rates are low) – is important.
- A mortgage is a long term financial planning tool – it makes sense to get the right solution at the right time.
- Mortgage rates are close to an all time low and housing prices are rising, so it’s easier to qualify now and benefits are higher due to high home prices.
- Interest rates drive both mortgage payments and house prices, and many experts believe interest rates are headed up which will increase mortgage costs and may bring down housing prices.
Many financial planners compare getting a HECM Reverse Mortgage to buying insurance for your retirement. The reverse mortgage just gives you access to more money and more options. The up front costs of the product may be a very good trade off for the piece of mind you have by creating options for your money.
If you are considering using home equity to insure your retirement you can get no obligation estimates and illustrations from lenders and think through whether setting up a reverse mortgage strategically makes sense for you.
