Bumpy Road in Retirement? Learn How a Reverse Mortgage Can Be Your Spare Tire
A reverse mortgage can be a spare tire for your retirement — there if you need it…
Just like you carry a spare tire in your car for when you get a flat, you might want to consider a reverse mortgage as a way to keep your lifestyle rolling if something happens financially during your golden years.
There has been a growing acceptance among financial planners lately for using home equity, particularly through the use of a reverse mortgage, as a backup plan.
In the event of a stock market downturn, a health emergency or any personal hardship, funds from a reverse mortgage can provide you with another source of wealth, enabling you to maintain your lifestyle during retirement.
Home is where the wealth is
For many retirees, their home is a valuable source of net worth. The average married couple entering retirement will have roughly $192,000 in home equity, but only $92,000 in non-equity assets, according to the U.S. Census Bureau.
“If households are assumed to draw on that equity in retirement via tools such as a reverse mortgage, it will make them appear to have far more assets available than otherwise,” stated the Center for American Progress in a 2015 report titled “The Reality of the Retirement Crisis.”
However, if households don’t liquidate the entirety of their assets (including home equity), the Center finds that the share of households considered at risk of not having enough money to maintain their standard of living in retirement will rise.
Converting home equity into cash flow
To get access to your home equity, you could sell your home and move into a less expensive residence. However, if you want to stay in your existing home, a reverse mortgage is an interesting option that is growing in popularity.
Read more below, or learn more about the pros and cons of reverse mortgages.
A reverse mortgage allows homeowners age 62 and older to convert a portion of their home equity into funds that they may use at their own discretion. Homeowners essentially borrow against their home equity in return for loan advances, which are not subject to state or federal income tax.
Unlike a conventional mortgage, like the one you used to purchase your home, a reverse mortgage does not require a monthly payment. But similar to a regular mortgage, reverse mortgage borrowers must continue to pay property taxes and homeowners insurance.
The most common reverse mortgages found on the market today are loan products insured by the Federal Housing Administration called Home Equity Conversion Mortgages (HECMs).
To be eligible for a HECM, you must be at least 62, have sufficient equity in your home, own your home outright or have a mortgage balance that can be paid down using the loan proceeds from the reverse mortgage. Loan applicants will also be assessed on whether they have the financial capacity to maintain ongoing loan terms, including the timely payment of property taxes and insurance.
HECM borrowers may choose to receive loan proceeds in several different ways, including a single lump sum disbursement, monthly term payments for a certain period of months, or tenure payments for as long as they continue living in their home.
Another option, the reverse mortgage line of credit, is becoming increasingly popular in financial planning strategies for its ability to provide retirees with a growing pool of funds that isn’t affected by market volatility.
Reverse mortgage line of credit
A HECM line of credit can also be a great resource to help retirees reduce market risk, especially when it comes to selling stocks at a loss, according to Jamie Hopkins, a professor of taxation at The American College in Bryn Mawr, Pa.
“For example, you might be better off meeting your income needs by borrowing from your home through a HECM line of credit than by selling your stocks when they are down 20 percent,” Hopkins wrote in an article for CNBC.
That’s because the HECM line of credit has a growth feature, which means that the unused loan balance grows over time. This isn’t the same as earning interest. Rather, the line of credit growth feature takes into consideration that you are one year older and that your home has appreciated in value.
The HECM line of credit can:
- Provide retirees much-needed income
- Allow them to age in place
- Help them avoid depleting their savings too quickly
- Increase the longevity of a person’s retirement portfolio (Recent financial planning research has shown that a HECM line of credit, when taken at the start of retirement and then left to grow, can significantly increase in value.)
Reversing the conventional wisdom
Historically, the conventional wisdom has been to use a reverse mortgage only as a last resort once all other investments have been depleted. As recent research has found, this is the absolute worse strategy for using home equity.
If, however, a retiree obtained a reverse mortgage at the beginning of retirement and let the line of credit grow over time, this would give them another bucket of funds to draw upon once they run out of other savings.
“The strategy which uses home equity as a last resort, but which opens a line of credit at the start of retirement in order to let the line of credit grow before being tapped, provides the highest increase in success rates,” writes research author Wade Pfau, principal at McLean Asset Management in McLean, Va.
More than 90% of reverse mortgage borrowers establish this “standby” line of credit strategy that they only access when funds are needed, according to the National Reverse Mortgage Lenders Association, an industry group that provides a variety of reverse mortgage resources for consumers on its website.
Does your retirement need a spare tire as a backup?
When driving, you carry a spare tire in case you get a flat. When retired, should you have a reverse mortgage in place in case you need the funds?
If you would like to learn more about reverse mortgages you can try taking a Reverse Mortgage Suitability Test to see if a HECM could be a good fit for your retirement plans.