Expert Report that Reverse Mortgages Are No Longer Just for Struggling Homeowners

You can turn your home equity into cash to pay off bills or preserve other savings or investments. They are complicated and not for everyone.

Janice Keese decided not to make any major decisions after her husband’s sudden death in 2016. Janice Keese waited two years before she could retire as a financial advisor and three more to sell their home and purchase a Reston, Va. lakeside townhome which she purchased with an FHA Insured Reverse Mortgage. 

Ms. Keese, who is 75 years old, had $150,000 in cash reserves and the reverse mortgage as a backup. She said that if something unexpected happened, it could be during a downturn in the stock market and could make it the wrong time to sell assets. Reverse mortgage borrowers have the option to take the money in a lump sum, fixed monthly payments, or as a credit line. Ms. Keese selected a line credit that she could access as needed.

Her cash reserves were exhausted within a year and Ms. Keese started using cash advances from her reverse mortgage. Her expenses included $50,000 for emergency dental care and a down payment to secure a place in a retirement community that will open in 2025. The line of credit grows monthly if it is not used so it is prudent to only access what is needed, this helps the reverse mortgage line of credit last longer.  Remember, no mortgage payments are required on reverse mortgages until one dies and the home is sold or refinanced by the heirs.

It was the thought that a reverse mortgage was only an option for elderly homeowners who needed cash urgently. Researchers are proving that these loans may be an option for those who have no need, such as Ms. Keese, earlier in retirement.

Reverse mortgages are a great way for homeowners in their 60s or early 70s to borrow cash to help protect their investment accounts when the stock market is trending down, delay the claiming of Social Security benefits to allow for larger payments and pay large medical bills.

Craig Lemoine is the director of the University of Illinois Urbana-Champaign’s financial planning program. “A younger retiree could stay in the home while turning equity into income stream,” Dr. Lemoine, who is also the executive director of Academy for Home Equity in Financial Planning. This group consists of housing and financial experts.

The basics of the new reverse mortgage

Homeowners 62 years and older (55 years old in some states) can get a reverse mortgage to borrow against their home’s value. The loan and interest will become due upon the death of the last surviving borrower, spouse or eligible non-borrowing spouse (non-borrowing spouses are not allowed in Texas).

Reverse mortgages allow you to borrow the maximum amount that you are eligible for based upon your age and the property value. Money you don’t use immediately, such as the untapped portion of a credit line, will be held in an account that is guaranteed to grow with time. Interest is only charged on the actual amount taken from the account. This is called the loan balance.

Reverse mortgages are Home Equity Conversion Mortgages (HECMs), which are insured under the Federal Housing Administration. The loan is non-recourse, meaning that the lender will not require any repayments as long as the original borrower remains in the home and does not default on property taxes, insurance and HOA dues if applicable. The FHA guarantees that the borrower will not owe more than 95% of the property’s value when the loan is paid off.  An appraisal may be required for a HUD-approved appraiser.

Borrowers pay an initial premium to the FHA in exchange for this guarantee. This premium is calculated based on 2% on the home’s appraised value. The origination fee could be as high as $6,000 but can be as little as zero and closing fees are similar to other mortgage loans. These costs can be paid upfront with cash or proceeds from a reverse mortgage. Later, you will pay interest.

“Because of the fee, we generally say, if you don’t think you will stay in the house for at least 3 years, a reverse loan may not be something that you want to do,” said Richard Woodward, a certified reverses mortgage specialist and licensed loan officers with NEXA Mortgage, who advises financial planners and loan officers on how to use home equity in retirement planning.

The loan amount is determined by your age, the interest rate, and your home value up to an FHA appraisal limit of $970,800 for 2022. This limit changes annually.

You can get an idea of how much a HECM will pay by using the calculator at RetirementResearcher.com, which is run by Wade Pfau, co-director of the American College Center for Retirement Income in King of Prussia, Pa.

Imagine you’re 65 years old and your home is worth $1 million. You would be eligible to borrow approximately $420,000 and your closing cost can be rolled into your new mortgage. This could be put in a line credit until you use it. You could also set up monthly “tenure” payments if you prefer or just call the loan servicer and request funds whenever you like.  No interest will be charged on your line of credit until funds are requested and added to your current loan balance.

Reverse mortgages Uses:

Ms. Keese stated that her reverse mortgage was only one component of a larger financial plan. She relies on the minimum required distributions from her individual retirement fund, income from maturing bonds in an taxable account, Social Security and a survivor benefit of her husband David’s corporate retirement pension.

She was eligible to borrow $370,000 when she opened her reverse mortgage. Most of this money is still unused in her credit line. She owes $81,000 at this point. This includes both the money she borrowed from her line of credit to pay expenses and the interest she accrued. She stated that her current borrowing limit, which is the amount of her credit line, is $329,000. This is because the line of credit has grown at that guaranteed rate all these years.

Ms. Keese stated that she would prefer to take tax-free money from her reverse mortgage rather than paying income tax on any additional withdrawals from her I.R.A. or Capital gains tax on stock sale in her taxable account.

The HECM will also allow her flexibility in paying the entrance fee for the continuing care retirement community she intends to move into over the next few years. The HECM money and the proceeds of the sale of a California home she co-owns could be used by her. She could sell her townhome in the right market conditions and repay the loan balance.

She stated that she wanted to be able to move, without having to rely on the sale of the townhome. It stresses me out when it comes to thinking about it.”

Protecting the Nest Egg

A portfolio’s longevity can be affected if it is subject to withdrawals from an investment account during market downturns. This is especially true for those who retire early. According to multiple studies, a retired person who has a coordinated strategy could protect their savings and cover expenses by using funds from a reverse-mortgage when the market drops.

Barry Sacks, a pension attorney, said that taking from a portfolio can drive it down further and make it harder to come back. He conducted studies which showed how a reverse mortgage could be used during market downturns to help portfolios stay on track.

This strategy is best for retirees with an investment portfolio of $500,000 to $1 million, according to Mr. Sacks. He has a reverse mortgage on one his Northern California homes.

A December 2021 study by Mr. Sacks with co-researchers showed that retirees who followed a coordinated strategy were less likely to run out over the next 30 years in different scenarios. This is in contrast to the much higher risk of cash flow exhaustion for retirees who have not used reverse mortgages or who have opened them after reducing their investments.

Mr. Sacks suggested that retirees look at their portfolio in January to see how it compares to a year ago. If the portfolio has declined due to investments falling, retirees should draw cash from their reverse mortgage to cover the next year’s expenses and allow the investments to recover.

Reverse Mortgage Options and Education

Parents who want to preserve their home equity for their children can leave a greater legacy by implementing a coordinated strategy,” said Dr. Pfau, author “Reverse Mortgages: How To Use Reverse Mortgages To Secure Your Retirement.”

Dr. Pfau examined a hypothetical couple of 62-year-olds with a $435,000 initial home value and $870,000 in investment. Social security was included in their inflation-adjusted annual $76,000 income.

Dr. Pfau used historical data to determine that the reverse mortgage taken out by the couple after they had exhausted their portfolio would have left them with nearly $1.8million in tax-free equity.

They could have depleted their home equity, but still left $2.2 million worth of after-tax assets if they had used the coordinated reverse mortgage strategy.

Dr. Pfau stated that “to the extent people are concerned about legacy, they shouldn’t be worried about the distinction between investments and home values.”

Dr. Pfau stated that a growing credit line could be used to finance other goals such as home health care or paying for lower savings. He said, “If I open the credit line sooner and allow it to grow, I’ll have more borrowing capability.”

Dr. Pfau said that early retirees can use a HECM to delay claiming Social Security until they are 70. People who wait until 70 to receive their monthly lifetime benefits are 77 percent better than those who claim at 62.

The bridge strategy allows you to take out a loan at 62, and then use it for all or part of your Social Security benefits for eight year. Dr. Pfau discovered that a couple who used a bridge strategy to preserve their net worth was more likely than those who claimed earlier and opened a reverse loan after exhausting savings.

He said that one reason is the existence of greater monthly benefits over the life of the retiree. Another is the potential for the portfolio to grow since the retiree does not take out any withdrawals for expenses.

Be aware of the caveats

The federal government has tightened its rules regarding loans in recent years. This includes limiting the amount a borrower can borrow for the first year, and ensuring that a spouse who is not a borrower can stay in the home after the borrower’s death.

Prospective borrowers need to be aware of the potential downsides. Although a homeowner might be careful about using the loan, perhaps to make an annuity-like monthly payment, it can be tempting to spend unnecessary money and deplete home equity before you die.

Dr. Lemoine stated that there is always danger in an influx of flexible, sudden cash. A reverse mortgage could be a bad decision for someone who is not able to maintain their home and would be better to downsize or move into a care facility. Experts advise prospective borrowers to assess their future health needs. A large loan balance can leave borrowers with insufficient equity if they need to sell their home or pay for assisted-living or nursing-home care.

Dr. Lemoine recommended that potential borrowers speak with several lenders before making a decision. He said that lenders “can negotiate some closing costs.” All borrowers are required to attend mandatory counseling sessions. He said that a financial advisor could and should help someone determine if a reverse loan fits in with their overall retirement plan.

A HECM could be a good option for older people with regular mortgages. Mary Johnson (76), a Napa real estate broker, obtained a reverse mortgage of $300,000. She used $250,000 to pay the traditional mortgage and left $50,000 in a line credit.

This allowed Ms. Johnson, to eliminate $2,200 per month she was spending on her mortgage payments. Social Security, investment properties and sales commissions make up the rest of her income.

Ms. Johnson stated that “as an independent contractor my income is erratic.” “The reverse mortgage gave me some stability.”

Ms. Johnson enjoys the fact that her credit line has increased to $70,000, despite the compounded interest she will have to pay.

She said, “It’s an excellent way to save.” “The interest rate on the line of credit is higher than any other I could find anywhere else.”

She said that her children are financially doing well and wouldn’t be worried if they didn’t inherit significant home equity. She said, “My children want me to be comfortable.”