Retirement can feel scary. In fact, it sometimes feels like you are in a tiny boat up against a huge and unpredictable storm with a rocky shoreline ready to break up your way of life.
However, you have navigated your financial life this far and — believe it or not — you can chart your course to smooth sailing and a happy retirement. If you own your home, the equity you have saved can work like a lighthouse to secure your way.
If you own your home, you can weather almost any retirement storm.
Until recently, a secure retirement was dependent on what has long been called the “three-legged stool.” Most people could make retirement work with:
- Social Security
- A pension
- Personal savings
However, times have changed. Very few of us have a pension and we have not saved enough to make up the difference. Our stool has two legs when it really needs three. Or, instead of a stool, you might consider that we have two oars, but no sail to help us get through the financial storm.
The good news is that there is a ray of very bright light in this story. Most retirees are homeowners and our homes are usually our most valuable asset. When you don’t have a pension, your home equity can fill-in to help fund retirement. Your home can be the lighthouse that saves your retirement from ruin.
A reverse mortgage is a federally-insured loan product that allows homeowners age 62 and older to access a portion of their equity either via a lump sum, through monthly payments, or at a later date in an established line of credit. The vast majority of reverse mortgages found on the market today are known as Home Equity Conversion Mortgages (HECMs), which are insured by the Federal Housing Administration.
“[Reverse mortgages] aren’t for everyone, but it’s my expectation that they will become increasingly important as a source of retirement income to seniors over time,” writes Don Taylor, a personal finance adviser, in a Bankrate.com article. “Reverse mortgages may become the 3rd leg of the stool.”
To qualify for a reverse mortgage, you must be at least 62 years of age and own your home outright, or have a mortgage balance that can be paid off at loan closing. The proceeds received from a reverse mortgage are considered loan advancements—not income—and therefore are not subject to federal or state income tax.
With a reverse mortgage, the loan balance accrues over time. Borrowers are not required to make monthly payments to the loan balance, as they would with a traditional “forward” mortgage. However, they are still responsible for paying property taxes and homeowner’s insurance on their property—just as they would with a regular mortgage.
It is important to note that the amount of home equity you access from the reverse mortgage needs to be paid back at some point. Typically, the loan balance becomes due and payable when the borrower dies or no longer lives in the home as a primary residence.
We all know that storms at sea can happen somewhat unexpectedly. Good sailors have back up plans. Charts, life jackets, a good knowledge of the sea and hopefully a lighthouse on shore to show you the way. The same is true of your retirement finances. You don’t know when stock market turmoil might happen. Wouldn’t it be nice to have a back up plan if a financial storm happens?
A reverse mortgage can be that back up plan.
An important aspect of using home equity in a retirement income plan is that retirees can use a reverse mortgage as a “buffer asset” at times when the investment markets are down.
Rather than selling-off shares at a loss during bear markets, you can instead draw from the reverse mortgage line of credit to supplement your needs for cash flow in years when their investment portfolio suffers negative returns. This is important for retirees to consider, especially when deciding whether or not you want to sell-off investments such as stocks.
If you were to follow the conventional “last resort” wisdom, that is getting a reverse mortgage only after all other assets have been depleted, you would have only a 40% chance of having enough money left in your retirement portfolio after 30 years spent in retirement, according to research published in the Journal of Financial Planning by Wade Pfau, professor of retirement income at The American College in Bryn Mawr, Pennsylvania.
But let’s say you took a reverse mortgage line of credit at the youngest eligible age of 62.
The line of credit option is unique because the funds held in the credit line grow over time. Like all reverse mortgage payment options, the amount of home equity you may be eligible to access via the credit line is based on your appraised home value, interest rates and your age (or age of the youngest spouse, in the case of couples).
If you took a line of credit at age 62, and didn’t tap any of the equity until your investment portfolio was depleted, you would have a 90% chance that your money would last you throughout a 30-year retirement, according to Pfau’s research.
“Even if the market recovers, your portfolio can’t recover at nearly the same rate, because you’ve already taken that money out of stocks, and it’s gone forever,” Pfau said in an article with The Wall Street Journal.
A reverse mortgage can provide a buffer to help retirees mitigate risks of loss in a bear market, however, determining whether or not home equity is the right fit for a person’s retirement income plan largely depends on their own, personal financial circumstances and goals.
If you would like to know more about reverse mortgages, and how this loan product might be suitable for your retirement plans, try using our free online Reverse Mortgage Suitability Test or Reverse Mortgage Calculator today.
