When is a Reverse Mortgage a Good Idea?
If you are heading into retirement and you want to make sure you have enough money to last throughout your golden years, you may be looking around for other sources of income.
One option for many retirees is a home equity conversion mortgage (HECM), commonly known as a reverse mortgage.
A reverse mortgage can be a powerful financial tool that gives retirees a way to tap into their home equity without taking on monthly mortgage payments, but there’s a lot of confusion about who a reverse mortgage is for and when it makes sense to get one.
Should you wait until you absolutely need it or is a reverse mortgage something that can be used earlier in retirement?
We’ll explore the factors that can help you determine when it makes sense to get a reverse mortgage.
What is a Reverse Mortgage?
Before diving into when to get a reverse mortgage, let’s first define what it is. A reverse mortgage is a federally backed home loan that allows older homeowners to convert part of their home equity into cash.
In order to qualify for a reverse mortgage, at least one homeowner must be at least 62 years old, have equity built up in the home, and the home must be their primary residence.
The first thing a reverse mortgage will do is pay off the current traditional mortgage, if there still is one. With the remaining funds, borrowers will then have several options for how to receive their money: a lump sum payout, monthly payments, a line of credit, or a combination of those methods.
The amount of money that a homeowner will be able to receive is based on the age of the youngest borrower, the market value of the home, and current interest rates.
While reverse mortgage borrowers are not required to make monthly mortgage payments, they are still required to pay property taxes, homeowner’s insurance, home maintenance costs, and homeowner’s association fees, if applicable.
There are no rules about how a reverse mortgage funds have to be used, which gives borrowers a lot of flexibility.
A reverse mortgage is paid back when the homeowner chooses to sell the property, the home is no longer the primary residence of the homeowner, or in the event of the homeowner’s passing.
When is a Reverse Mortgage a Good Idea?
There are several factors that will determine when it makes sense to get a reverse mortgage including what you need it for, your financial situation, and your other retirement plans.
For many retirees, a reverse mortgage can be a helpful tool to supplement their income and increase cash flow. This is especially true if they have limited savings or investments that they need to stretch throughout their retirement years.
We will explore a variety of scenarios below where it may make sense to consider a reverse mortgage loan.
To Bolster Your Retirement Portfolio
For many years, a reverse mortgage was viewed as a tool someone would only use as a last resort when they get to a point where they are short on cash. But this view has changed. Retirement experts now say that a reverse mortgage can be used strategically as part of someone’s overall retirement plan, according to a report by The New York Times.
“Financial planning research has shown that coordinated use of a reverse mortgage starting earlier in retirement outperforms waiting to open a reverse mortgage as a last resort option once all else has failed,” wrote financial planning expert Dr. Wade Pfau.
Pfau says that a reverse mortgage creates “liquidity from an otherwise illiquid asset.”
While funds from a reverse mortgage can be received as a lump sum and monthly installments, they can also be received as a line of credit. The primary advantage to the line of credit option is that the principal limit grows over time and throughout a person’s retirement. For reference, the principal limit is the amount that a borrower is eligible to borrow.
“This principal limit growth will almost always allow for greater access to funds later in retirement than if you instead waited to open the reverse mortgage until later when it is first needed,” Pfau explains.
In other words, you can still hold off on using the money until you need it, but if you take out that reverse mortgage loan sooner rather than later, you will have more money available to you when that time comes.
During a Market Downturn
It can be devastating for those who retire when the stock market, and their retirement accounts that are tied to it, are in the middle of a market downturn.
This is where turning to a reverse mortgage may be the solution they need while they wait out a bear market. Pfau says that a reverse mortgage can be used to take pressure off investment accounts and “having to sell assets at a loss.”
A reverse mortgage can provide “an alternative source of retirement spending after market declines, creating more opportunity for the portfolio to recover,” he explained.
You Want to Retire in Place
A reverse mortgage offers a practical solution for individuals approaching retirement who are looking for a way to afford to retire in their own homes. While a reverse mortgage can help with covering monthly bills, it can also be used to fund home improvements to bring your home up to date, if needed.
While there is an abundance of retirement communities in states like Florida and Arizona, research suggests that the majority of retired Americans prefer to stay put.
According to a study by the Center for Retirement Research, most retirees continue living in the same homes they occupied in their early 50s. Thus, reverse mortgages can play a pivotal role in supporting this preference, allowing retirees to remain in the home and the community they love.
When Social Security Isn’t Enough
If homeowners find that Social Security payments and other sources of income aren’t cutting it, they may look for other ways to supplement their income.
A reverse mortgage can help with this in two ways. First, it doesn’t require monthly mortgage payments to pay it back. This can help if the homeowners still have a traditional mortgage on the home as mortgage payments are typically the largest bill they pay each month.
Second, it allows homeowners to receive additional funds in the form of monthly payments. This method for receiving reverse mortgage funds may be ideal for those looking to offset monthly bills and expenses.
To Delay Social Security Benefits
The longer an individual puts off claiming their Social Security benefits, the more they are able to receive per month.
The one downside is that delaying Social Security claims may create a temporary income gap for retirees. This is where the strategic use of a reverse mortgage comes into play. A reverse mortgage allows homeowners to convert part of their home equity into cash, which can serve as a supplementary income source during this waiting period.
By using the funds from a reverse mortgage to fill in the gap, retirees can comfortably sustain their lifestyle while postponing their Social Security benefits. This enables them to maximize their long-term financial resources, ensuring a more secure and comfortable retirement. It’s a practical approach that intertwines the benefits of both a reverse mortgage and delayed Social Security claims, providing a robust financial strategy for retirement.
When Not to Get a Reverse Mortgage
A reverse mortgage loan isn’t for everyone. Here are some reasons why a reverse mortgage may not be right for you or why you may want to delay getting a reverse mortgage.
If You Plan to Move Soon
It is generally recommended that homeowners don’t pursue a reverse mortgage if they plan to move within the next couple of years. This is mostly applicable if you plan to purchase a new home when you sell the home. The reason for this is that a reverse mortgage loan is taken out against the equity in the home, which won’t leave a lot of equity left to use toward a new home purchase.
Alternatively, homeowners who plan to relocate may be able to take advantage of a home equity conversion mortgage for purchase (HECM for purchase). A HECM for purchase allows homeowners to finance a portion of their new home purchase with a reverse mortgage combined with a down payment from the sale of their previous home.
If You Want to Pass Your Home to Your Children Free and Clear
A reverse mortgage does not prevent you from leaving your home to your children or heirs, but because it is a loan that is borrowed against the equity in your home, you won’t be able to leave it to them free and clear.
In order to assume ownership, your heirs will have to pay off the reverse mortgage loan, which they can do by paying for it with cash or taking out a traditional mortgage on the home.
If You Can’t Afford It
As previously mentioned, to obtain a reverse mortgage, you will still be responsible for ongoing expenses such as property taxes, homeowner’s insurance, HOA fees, and home maintenance costs. Although a reverse mortgage can help cover these costs, if you anticipate difficulty in meeting these obligations, it may not be the most suitable option for you.
Prior to proceeding with the application, most reverse mortgage lenders will evaluate your financial situation to ensure that you meet all the necessary requirements.
Reverse mortgage loans can indeed provide a financial cushion. However, they’re not suitable for all situations.
A reverse mortgage may make sense if you are looking for a way to bolster your retirement portfolio, you are retiring during a market downturn, or if you want to retire in place.
Factors such as how long you plan to remain in your home, if you want to leave the home to your heirs free and clear, and the ability to pay ongoing costs also need to be thoroughly assessed.
Always remember, it’s important to seek advice from a financial advisor and consider all your options before deciding on a reverse mortgage.
Borrower must occupy home as primary residence and remain current on property taxes, homeowner’s insurance, the costs of home maintenance, and any HOA fees. These materials are not from HUD or FHA and the document was not approved by HUD, FHA or any Government Agency. Subject to credit approval. For licensing information, go to: www.nmlsconsumeraccess.org
Reverse mortgage borrower must occupy home as primary residence and remain current on property taxes, homeowner’s insurance, the costs of home maintenance, and any HOA fees.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.