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January 26, 2015
How could a reverse mortgage be a great financial planning tool? A little-known feature of reverse mortgages is being recognized by financial planners as a way for people 62 to have an additional revenue stream in retirement.
Nearly 78% of all older adult households do not have sufficient resources to sustain them through their retirement years, MetLife researchers estimate in a study on the changing role of home equity and reverse mortgages.
And if you’re concerned about how to maintain your lifestyle in retirement, you’re not alone.
More than 70% of boomers expect that they will have to delay retirement, and half fear they will not be able to afford to retire, according to AARP.
But taking out reverse mortgage as a line of credit can help — and funds become more substantial the longer they are left untouched, providing a significant revenue stream in your later years.
A reverse mortgage is a loan against the equity that you have in your home. The funds made available through a reverse mortgage can grow substantially over time when taken as a line of credit.
Taking out a line of credit is one of the most popular ways a reverse mortgage is used, says Lester Tutak, regional reverse mortgage specialist, with PEARL Mortgage’s Schaumburg, Ill. branch.
“Over the past two years, the reverse mortgage has turned from being used on a need basis to more of a financial tool that can improve quality of life,” he says. “Maybe a couple has struggled all their lives and never spent any money to update their home. Now they can use that money to remodel, or make the home more senior-friendly — or maybe now they can go on that vacation they always wanted to. It opens up a world of opportunities.”
What is a reverse mortgage?
In order to take out a reverse mortgage as a line of credit, you must qualify for a reverse mortgage first.
A reverse mortgage is a loan that enables homeowners aged 62 or older to borrow against the equity in their home without having to sell the home, give up title, or take on a monthly mortgage payment. The home equity conversion mortgage (HECM) is the most common type of reverse mortgage, and is administered through a program under the U.S. Department of Housing and Urban Development.
The government determines how much borrowers are eligible for based on their age, home value and current interest rates.
When receiving a reverse mortgage, borrowers can opt for a fixed-rate or adjustable-rate HECM.
Fixed-rate HECM: Loan borrowers will receive the cash in a lump sum, and the rate is set and fixed for the full duration of the loan.
Adjustable-rate HECM: Loan borrowers can select one option or a combination of distribution methods, including as a line of credit.
Receiving a reverse mortgage through a line of credit is the most popular distribution method, Tutak says.
Reverse mortgage line of credit
The line of credit features unscheduled payments or installments, meaning you can take out funds at any time and in the amount of your choosing (subject to a first-year cap and the overall principal limit—or total amount that can be borrowed) until the line of credit is exhausted. You may also make payments back toward the line of credit.
The amount available to the borrower in the reverse mortgage line of credit increases every month by a pre-determined amount, based on the previous month’s credit line balance and the current interest rate.
The interest rate is determined by the London Interbank Offered Rate (LIBOR), — a benchmark rate the world’s banks charge each other for short-term loans — plus a set margin.
Even if you don’t need the funds from a reverse mortgage now, if you suspect a reverse mortgage will be of benefit to you down the road, borrowing sooner than later could increase the funds available to you over time.
As long as you continue to meet the requirements of your reverse mortgage, your credit line cannot be frozen or canceled.
Having a cushion of readily accessible funds can encourage older homeowners to act sooner, to keep small problems from becoming a costly crisis.
“For example, carbon monoxide fumes from faulty furnaces, gas water heaters, and ranges can have a serious effect on people with heart disease,” the Metlife study says. “Replacing a leaky roof or faulty furnace before they cause structural damage or a serious illness reduces the chances that a person will exhaust their retirement savings.”
Using a reverse mortgage line of credit to provide revenue can help you to delay taking Social Security, Tutak says.
“Through meeting with an accountant or financial planner you can devise a strategy of delaying Social Security and utilizing a reverse mortgage line of credit to compensate for that time period,” he says.
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