Reverse Mortgage - Friend or Foe?Submitted by Breakwater Financial, LLC on November 28th, 2018
The reverse mortgage, or technically known as the Home Equity Conversion Mortgage (HECM), is not the most popular retirement income tool. Some say they are expensive, that they will hurt your children's inheritance, that your spouse will get kicked out of your house when you die, that they should be used only as a last resort, or that your loved ones will be on the hook for the debt. We've all heard the arguments against them. But are these beliefs valid? Is it possible that everything you think you know about reverse mortgages is ill-informed? If so, then read on.
Reverse mortgages admittedly have a less than stellar past. Many of the concerns regarding reverse mortgages stem from the earlier, darker days of the product. However, thanks to new regulations developed over the years, they have evolved. I would argue that they have evolved so much, that they are now a legitimate retirement income tool that should be considered by many retirees.
Let's start with the basics. An HECM Reverse Mortgage is federally insured through the Federal Housing Authority (FHA). And I would only recommend considering a Reverse Mortgage that is Federally insured. By taking out an FHA-insured reverse mortgage, you are protected from the bank re-possessing your house or being forced to sell provided you meet certain requirements - staying current on property taxes, maintaining homeowners insurance and keeping up with regular maintenance. After you die, your loved ones can decide if they want to pay off the mortgage, refinance, or sell the home and take the remaining equity (if any). But your estate will not be on the hook if the loan balance is greater than the balance of the reverse mortgage. That's part of the guarantee you're paying for when you take out a reverse mortgage. As long as both spouses are named as borrowers, the same protections extend to your spouse after you pass. At least one spouse must be 62 years old to qualify for an HECM.
You have three options when you take out a reverse mortgage: take a lump sum, set up a lifetime annuity, or set up a line of credit (or some combination thereof and it can be changed down the road). For the purpose of this article I'll focus on the last option, the reverse mortgage line of credit. The line of credit is a versatile retirement income tool. You may never use it; a better strategy may be to use it to fund living expenses in years when the markets are down. This way you'll avoid needing to sell investments when they are trading lower. You can ride out a market downturn without lowering your standard of living or possibly permanently damaging your retirement income strategy.
There's also a little known fact about the reverse mortgage line of credit that was probably unintended in the design but can be very impactful for someone who plans well. The available borrowing amount under the line of credit grows over the life of the loan, assuming you don't use it (and possibly if you only use some of it). And this growth will most likely outpace the growth in the value of your home. So, by taking out a reverse mortgage early in retirement, you have a bucket of available funds that is growing in retirement, while many of your other accounts may be shrinking.
Let's examine some of the arguments against reverse mortgages.
I plan to take out a reverse mortgage only as a last resort
This preference is prevalent but there are a couple of things to consider. First, as mentioned above, the line of credit will grow over time and most likely faster than the value of your home. So if you delay, then you may not be able to borrow as much. But more importantly, perhaps you should also consider what would happen if you pass away before your spouse. Your spouse may then need a reverse mortgage to cover living expenses, but may fail to qualify for one now that you are gone. To qualify for a reverse mortgage, you need to be able to prove that you have the resources to pay for the expenses and taxes related to your home. If you wait until later in retirement, your surviving spouse may not have those necessary resources.
I'll just take out a less expensive home equity line of credit instead
This of course is an option, but you need to remember that the bank can choose to cancel and/or freeze your line of credit. They can cancel/freeze it at the worst possible time. It happens. You pay more for a federally insured reverse mortgage because you are buying a guarantee that the loan cannot be canceled simply due to a change in circumstances - like a change in the value of your home or a change in your income - so long as you are current on property taxes, homeowners insurance, and maintenance.
By taking out a reverse mortgage, I will reduce my children's inheritances
It's possible, but it's also possible that you may end up leaving your children more of an inheritance rather than less of one. The distributions from a reverse mortgage are tax free. By using a reverse mortgage to fund some expenses, this may allow you to delay taxable distributions from your retirement accounts and you could allow those retirement accounts to grow tax deferred for a longer period of time. A reverse mortgage may also allow you to delay taking Social Security longer. These two alone could mean a higher net worth, and thus a larger inheritance to your children, upon your passing.
I want to be debt-free in retirement
It's understandable and noble to want to go into retirement debt-free. Being debt free should be a goal at any stage in your life. But would you view a debt that you'll never be required to pay back in your lifetime as the same kind of debt that you've avoided your entire life? I think with reverse mortgages, you need to look at the entire picture - look at all of the pros and cons, and then ask yourself, "Which is a better choice for me?". Depending on your unique situation, you may need to decide between a preference for a debt-free retirement, or a preference for optimizing your retirement income.
Reverse mortgages are expensive
Reverse mortgages are certainly not cheap to establish compared to other forms of home equity. The largest cost in establishing a reverse mortgage is the insurance premiums you are paying to the FHA to fund the guarantees embedded in the product. Additionally, If you carry a balance, it will accrue interest. However, you'll never be required to pay that interest during your lifetime.
Let's look at an example. Joe and Sue own a $1,000,000 home in Arlington, Massachusetts that they have paid off completely. They have both just turned 62 and would like to take out a Federally insured reverse mortgage line of credit. Assuming they meet all of the other requirements, they would be able to establish a line of credit in the amount of approximately $277,977 (as of the time of this writing.) The amount they can borrow from the line of credit would initially be growing at 4.93% annually. The closing costs, including the insurance premiums, would total $22,697. The closing costs will vary somewhat from bank to bank for items other than the FHA insurance premium amount. Many choose to take the closing costs from the line of credit so they pay nothing out of pocket and up-front, but then they would have a balance that would also be growing. You can run the numbers for yourself here using this calculator from the Reverse Mortgage Lenders Association.
Depending on your situation, a reverse mortgage may or may not improve your retirement income strategy. The purpose of this blog post is simply to give you the opportunity to examine your assumptions about reverse mortgages to make sure they are well-founded. With this knowledge you can make a decision based on facts rather than hearsay. As always, I welcome the opportunity to discuss how a reverse mortgage may or may not fit into your unique retirement plan.
Breakwater Financial, LLC is a registered investment advisor. The content of this blog post is for informational and educational purposes only and is not to be considered investment advice. If you have any questions regarding this Blog Post, please contact us.