The effectiveness of a reverse mortgage is determined by the borrower’s retirement goals
Reverse mortgages have undergone substantial changes over the past year to make them safer for retirees. But just like many other financial products on the market today, reverse mortgages are not for everyone.
A reverse mortgage allows homeowners age 62 and older to convert their home equity into tax-free proceeds, which they can use at their own discretion. Unlike a traditional forward mortgage, which require principal and interest payments to decrease the loan balance, reverse mortgage borrowers receive proceeds from the lender.
Although reverse borrowers are not required to make monthly payments toward the loan balance, they are required to remain current on their property taxes and homeowner’s insurance. Failure to do so triggers the reverse mortgage loan balance — a balance which grows over time — to become due and payable.
In years past, reverse mortgages were considered loans of last resort, used in many cases by the financially desperate as a means to increase cash flow during retirement once all other assets have been depleted. This is no longer the case.
“Although they’re no longer considered loans of last resort, reverse mortgages can still help borrowers who do have immediate needs. . . .”
New rules that took effect in April 2015 have improved the qualification requirements for reverse mortgages, making them safer products for borrowers to use in sustaining themselves during the course of retirement. These new program tweaks have, as a result, caught the attention of financial planners, many of whom are finally recognizing reverse mortgages as viable retirement planning tools.
But even though there has been a slew of research in recent years demonstrating the benefits of reverse mortgages when used as part of a coordinated retirement income strategy, the true effectiveness of these products is largely determined by the individual borrower’s retirement goals, including their personal lifestyle wants and financial needs.
What are your personal needs?
Unfortunately, reverse mortgages do not provide a one-size-fits-all financial solution to retirement planning. Although they’re no longer considered loans of last resort, reverse mortgages can still help borrowers who do have immediate needs, particularly for those who might be cash poor, but house rich—and need money now. They can be even more effective and beneficial for financially stable retirees who use them strategically.
There are three categories of homeowners who are benefitting from getting a reverse mortgage today, says Dan Hultquist, an Atlanta-based Certified Reverse Mortgage Professional (CRMP) with Open Mortgage, and author of “Understanding Reverse.”
Now in its latest 2016 edition, “Understanding Reverse” is a comprehensive guidebook meant to simplify reverse mortgages by addressing the most common questions and misconceptions of the product.
“A reverse mortgage can provide additional, much-needed cash flow to help retirees meet any number of retirement’s unexpected hiccups.”
“Unfortunately, many perfect candidates will continue to believe that a Reverse Mortgage is ONLY for a desperate homeowner with plenty of equity and no cash,” Hultquist writes. “However, recent modifications by the Federal Housing Administration have highlighted the retirement planning advantages for the financially stable older homeowner.”
The first category of borrower to benefit from a reverse mortgage, according to Hultquist, are retirees who have an immediate need for extra cash flow. The loan proceeds received from a reverse mortgage are tax-free and there are no restrictions on how you choose to spend the money.
Reverse mortgage borrowers have commonly used their loan proceeds to pay for medical bills and health care services, to fund home improvement projects, and even for leisurely activities, including travel and other expenses.
Health care is often one of the most unpredictable, and most costly, retirement expenses that can derail a person’s financial plan. Yet, at least 70% of Americans over age 65 will require some form of long-term care during their lifetime, according to the most recent 2015 Cost of Care Survey from life insurance provider Genworth.
If you experience a significant health issue, or need in-home care to remain living in your house, your home equity can help cover the costs of these services.
“Monthly payments generated by home equity conversion can help when they, or their heirs, unable or unwilling to pay for these expenses,” Hultquist writes.
A reverse mortgage can provide additional, much-needed cash flow to help retirees meet any number of retirement’s unexpected hiccups. But, the simple need for money is not the only reason you need to get a reverse mortgage.
Planning for your future
For retirees who don’t have an immediate need for extra money, financial planners suggest using a reverse mortgage line of credit as a retirement planning strategy.
Because many homeowners have disproportionate amounts of their retirement savings held in real estate, drawing part of their monthly cash flow from their home equity nest egg will help their traditional retirement funds last much longer, says Hultquist.
The reverse mortgage line of credit allows homeowners to obtain a reverse mortgage without requiring them to make any immediate withdrawals. The amount of funds in the credit line, when untouched, grows over time at a compounding rate.
Unlike a traditional home equity line of credit (or HELOC), the reverse mortgage credit line is not capped and cannot be frozen by the lender. It also cannot be eliminated if property values decline.
“Because the reverse mortgage has the ability to create this growing alternate source of retirement cash flow, a homeowner’s Financial Planner will have the flexibility to manage his/her adjusted gross income for tax savings,” Hultquist writes. “More importantly, it can give homeowners peace of mind that they will be less likely to run out of funds.”
“A key theme is that there is great value for clients to open a reverse mortgage line of credit at the earliest possible age.”
Numerous studies have demonstrated the potential benefits of incorporating home equity into a retirement income strategy, primarily through the use of a reverse mortgage line of credit.
If obtained at the start of retirement, researchers have found that the credit line, if left to grow over time, can be an effective source of cash flow to protect a retiree’s investment accounts, including 401(k)s and IRAs, in the event those accounts suffer negative returns.
“Opening the line of credit at the start of retirement and then delaying its use until the portfolio is depleted creates the most downside protection for the retirement income plan,” says Wade Pfau, director of retirement research at McLean Asset Management in McLean, Virginia, and professor of retirement income at The American College in Bryn Mawr, Pennsylvania.
Pfau recently published a study in the Social Science Network detailing the various uses for reverse mortgages in retirement income planning and the different outcomes each strategy provides.
“Strategic use of a reverse mortgage can improve retirement outcomes,” Pfau writes in his research paper. “A key theme is that there is great value for clients to open a reverse mortgage line of credit at the earliest possible age.”
Family matters
Reverse mortgages can provide many benefits for retirees who are looking to achieve their financial goals. But, for reverse mortgages to be truly effective, they also need to accommodate your personal lifestyle needs and wants.
“It not only has to make sense right now, but also needs to provide a sustainable solution throughout retirement,” Hultquist writes. “If the reverse mortgage offers little current or future advantage to a borrower, then the homeowner should look for other options.”
That also means effectively communicating with your family members and other beneficiaries about your decision to get a reverse mortgage. After all, your surviving family will have to make some big decisions once you’re no longer around and the reverse mortgage becomes due and payable (e.g. selling your home or paying the loan balance themselves).
“You worked for that house and responsible children should agree that maintaining your standard of living comes first,”
If you do decide to get a reverse mortgage, tell your children and other beneficiaries. It’s in yours and their best interests to know, says Jane Bryant Quinn, nationally renowned personal finance writer for AARP and author of “How to Make Your Money Last” (Simon & Schuster 2016).
“You worked for that house and responsible children should agree that maintaining your standard of living comes first,” Quinn writes on reverse mortgages. “But they shouldn’t be taken by surprise after you die, learning suddenly that this piece of their expected inheritance is gone.”
The more your heirs know about the reverse mortgage in advance, Quinn says the better prepared they will be to handle the home’s sale or foreclosure process in the end.
If you are interested in learning more about reverse mortgages and would like to know how this product might fit into your retirement plans, contact a financial planner or reverse mortgage advisor today.
