Dear Carrie: My wife and I are in our 60s and looking at ways to reduce our expenses when we retire. We’ve considered downsizing, but after 27 years, our house and the neighborhood still fit us. Our home is finally paid for and is pretty manageable, except we worry about being able to pay for major repairs or health care in the future. Would a reverse mortgage make sense for us?—A Reader
Dear Reader: I’m glad you asked this question, because so many people are in exactly your situation, wanting to “age in place” rather than move to a smaller, less expensive home or a retirement community. But as you point out, maintaining a large home and paying for health care and other potential expenses can be challenging.
Congratulations on paying off your mortgage; that’s a major accomplishment and will certainly help your budget. If you still find yourself short of cash, a home equity loan (HELOC) or a cash-out mortgage could be options, but both would require you to make monthly payments. And as you suggest, a reverse mortgage could also make sense, provided you understand exactly what you’re getting into and how it ties into your larger financial picture.
On the plus side, a reverse mortgage will allow you to tap into a portion of your home equity without having to make monthly payments. On the downside, the fees and interest charges are typically higher than those for a cash-out refinance or HELOC. When combined with the amount of money you borrow, this can significantly erode the equity that you’ve built up in your home. Let’s go over more particulars so you’ll be able to make an informed decision.
Note: There are several kinds of reverse mortgage programs. I’m covering (and suggest that you only consider) what is known as home equity conversion mortgages (HECMs), or “heck-ums.” That’s because HECMs are regulated and insured through the federal government by the Department of Housing and Urban Development (HUD) and the Federal Housing Authority (FHA). Other types of reverse mortgages don’t have these protections.
Reverse Mortgage Basics
A reverse mortgage is a loan that uses your home as collateral. You can use the proceeds for anything from supplementing your income to paying off other debt to making a large purchase. Your house will remain in your name, and the income you receive is tax-free since the money comes from a loan. In addition, no matter how much you owe on a reverse mortgage, you can’t owe more than the value of your home (even if the loan balance is larger).
One of the biggest advantages of a reverse mortgage is that you’re not required to make payments as long as you remain in your home. However, once you leave your home for more than 12 months, sell it, or die, the outstanding loan must be repaid along with any interest—typically from the sale of the home.
Not just anyone can get a reverse mortgage. First, the youngest borrower must be at least 62. And the home must be your primary residence. You can’t take out a reverse mortgage on a second home or an investment property. You also must be able to demonstrate that you can maintain the property and pay property taxes, insurance, HOA fees, etc.
And, finally, you must own your home outright (or those who have a mortgage must pay it off with either the reverse mortgage proceeds or other funds before they can use the proceeds for anything else).
How Much You Can Borrow
The amount you can borrow is dependent on your and your spouse’s ages, the value of your home, and interest rates. The older you are, the more equity you have. And the lower the interest rate environment, the larger the amount you can borrow.
There’s a limit on how much you can take out the first year and an overall limit to how much of the value of the home you can borrow against. In 2020, the HECM FHA mortgage limit is $765,600. So even if your home is worth $1 million, the HECM will only let you borrow against $765,600 of its value. You would then be able to borrow anywhere from 35 percent to 75 percent of this amount, depending on your age, interest rates, and how much equity you have in the property.
Unlocking Different Retirement Strategies
Once you have the loan, you can take the cash in a few ways: a lump sum, a specified amount for a fixed number of years, monthly payments—as long as you remain in the home (tenure)—a standby line of credit to use when you wish, or a combination of fixed or tenure payments with a line of credit.
There are a variety of ways you can use a reverse mortgage to your advantage. For example, you could use it to build an income “bridge” in order to claim higher Social Security benefits later, protect against having to sell assets during a bear market, pay for taxes on Roth conversions, pay for home renovations, or even buy a new home.
It’s Not Free Money
A reverse mortgage can carry costs of up to several thousand dollars and typically add up to be much higher than a conventional mortgage or HELOC.
As a general rule, lenders will charge five things: mortgage insurance premiums (initial and annual), third-party charges, an origination fee, interest and servicing fees. You can either pay these fees upfront or by financing them over time from the proceeds of the loan.
Financing these costs will lower the amount you can borrow and eat away more of your home equity over time, leaving less to your estate. It’s important to understand that with a traditional mortgage, you build equity over time. With a reverse mortgage, you deplete equity that you’ve build up over time.
Some Final Thoughts
Reverse mortgages have gone through a number of changes over the years. Early on, they were often heavily marketed as a way to spend on luxuries or used by aggressive salespeople to cross-sell lucrative investment products. While these types of abuses still exist, there are now more safeguards.
Today, before applying for a HECM, you’re required to meet with a counselor from an independent government-approved housing counseling agency. You can visit HUD for a list of counselors or call the agency at 1-800-569-4287.
For the right individuals in the right situation, reverse mortgages can be a uniquely effective way to stay in your home during retirement. But it’s essential to think long term, weighing the benefits, costs and risks.
What if one of you has a health issue? How will a reverse mortgage impact a plan to leave the house to the kids? Or what if you just decide that your current home no longer suits your needs? Talk out all of these scenarios with your wife, your financial adviser, and possibly even your beneficiaries before you sign on the dotted line.
Carrie Schwab-Pomerantz, a certified financial planner, is president of the Charles Schwab Foundation and author of “The Charles Schwab Guide to Finances After Fifty.”