Financial advisors are seeing this FHA-insured loan program in a whole new light.
Reverse mortgages have changed quite a bit over the years. New rules have been put in place by the Federal Housing Administration (FHA) to protect consumers and ensure the health of this government-backed loan program for older adult homeowners.
As a result, whereas it was once seen as a financial tool of last resort, more and more financial advisors are realizing that it can actually be a useful retirement planning tool for seniors, as part of a comprehensive financial plan, to help make sure that people won’t outlive their money.
“House rich, cash poor”: what to do when most of your money is tied up in your home.
For many of today’s older adult homeowners, their largest retirement asset by far is their home. Unfortunately, too many of them have little knowledge of how to unlock this source of retirement income—home equity—to ease their financial burden and supplement their retirement planning.
A 2016 InvestmentNews article tells the story of a 67-year-old San Francisco woman who successfully used a reverse mortgage to supplement her retirement plan.
She owned her home free and clear, with no monthly mortgage payments. But after retiring, she watched her Individual Retirement Account (IRA) investments rise and fall in a volatile market. Fortunately, the value of her home kept increasing, leaving her with a significant amount of home equity.
This isn’t an uncommon situation among older adult homeowners—but unlike many who simply ignore their home equity, she decided to take full advantage of it. She realized that during those times when her investments weren’t doing well, she could draw money from her home’s equity using a reverse mortgage in retirement as a financial “buffer.”
This innovative idea is gaining traction in today’s complex retirement planning climate: incorporating home equity into a retirement income strategy using a Home Equity Conversion Mortgage (HECM)—also commonly known as a reverse mortgage—the FHA-insured loan program for homeowners age 62 and older.
According to the U.S. Census Bureau, the average married couple entering retirement will have roughly $192,000 in home equity—but only $92,000 in non-equity assets. Which makes it even more puzzling that senior homeowners and their advisors, by and large, tend to ignore this large pool of available funds when faced with retirement planning challenges.
An expert weighs in on the reverse-mortgage-in-retirement strategy.
Dr. Wade Pfau, Professor of Retirement Income at The American College of Financial Services, maintains that “Strategic use of a reverse mortgage can improve retirement outcomes” in his 2015 work, “Incorporating Home Equity into a Retirement Income Strategy.”
“For most Americans,” he wrote, “home equity and Social Security benefits represent the two biggest assets on the household balance sheet—frequently dwarfing the available amount of financial assets.”
In Dr. Pfau’s original research, he analyzed several studies on how to use a reverse mortgage as part of a comprehensive retirement income strategy. He concluded the best way to use a reverse mortgage in retirement may be to open a reverse mortgage line of credit at the earliest possible age—particularly in financial environments such as today, when interest rates are low.
With a reverse mortgage in retirement, the unused portion of the available line of credit continues to grow each year—even if the value of the home doesn’t. In addition to helping avoid depleting investment assets, a standby reverse mortgage line of credit can serve as a financial “safety net,” to have in case of unexpected large expenses or perhaps long-term care needs, in the future. And unlike a traditional home equity line of credit, a reverse mortgage line of credit cannot be frozen, reduced, or cancelled.
In 2017, further program rule changes increased upfront costs somewhat, and made the line of credit grow more slowly. However, after updating his analyses to reflect the changes, Dr. Pfau concluded in an October 2018 article that “the line of credit does remain a viable option and use for a reverse mortgage.”
Traditionally, the most popular use for a reverse mortgage has been paying off an existing mortgage to reduce fixed payments in the early years of retirement. And according to Pfau, “Arguably, the new rules have made using a reverse mortgage in this way more attractive.”
Older adult homeowners who are approaching retirement age and putting their plan together—or those already in retirement who wonder if they need a Plan B—may want to ask their financial advisor about a reverse mortgage.
In Dr. Pfau’s view, “financial advisors who maintain the conventional wisdom about reverse mortgages as only being worthwhile as a last resort should instead give them a second chance by updating their due diligence. The conventional wisdom is changing.”
The basics of how a reverse mortgage works.
It’s a type of loan that allows older homeowners to convert part of their home equity into cash that they can use for any purpose. There’s no “catch” to it, but there are some rules. To be eligible, you must be age 62 or older and either own your home outright or use the proceeds of the reverse mortgage to pay off your existing mortgage balance.
The home you take the loan out on must be your primary residence. Your name stays on the title, and you own it. There are no monthly mortgage payments required—all you must do is continue to pay property taxes and homeowners insurance, and keep the property well maintained according to program guidelines.
How much you can borrow is based on how much home equity you have, the age of the youngest borrower, and current interest rates. In general, the more home equity you have and the older you are, the more you can receive.
The money you receive is tax-free* and can be taken as a single payment, monthly payments, a line of credit, or any combination of these. Interest accrues monthly on the amount borrowed, not on unused lines of credit. No repayment is required until the last borrower permanently leaves the home. It’s a type of loan known as “non-recourse,” which means that you or your heirs can never owe more than the home is worth at the time of its sale, even if it’s less than the loan balance.
*Consult a financial advisor and appropriate government agencies for any effect on taxes or government benefits.
How reverse mortgages made a comeback.
In the early years of the program, the actions of some overly aggressive lenders led to a lot of bad press for the industry. And while some of the information out there was true, much of the word-of-mouth about the product among consumers was simply myth and misinformation.
Fortunately, in recent years the industry has dramatically changed for the better. The FHA increased consumer protections, introduced underwriting to weed out unsuitable candidates, and significantly lowered costs to make reverse mortgages accessible to more borrowers.
The Reverse Mortgage Stabilization Act of 2013 was designed to keep borrowers from using too much equity too soon. It also put protection in place for spouses too young to be co-borrowers on the loan, ensuring that they’re able to remain in their homes after the older spouse passes away. Later, a financial assessment tool was introduced to help seniors plan their retirement spending with a reverse mortgage—and make sure they can meet their financial responsibility to pay property taxes, home insurance, and property maintenance.
Despite all this, “Advisors have been slow to grasp how reverse mortgage lending has changed,” says Shelley Giordano, Chairperson of the Funding Longevity Task Force, an industry-backed group of leading retirement income specialists.
“If the first impulse is to counsel clients to wait until the portfolio is depleted before establishing a HECM line of credit, the advisor is giving outdated advice,” she said.
Reverse mortgage in retirement as an income supplement.
Even for older adult homeowners who don’t have a large investment “portfolio” to protect, a reverse mortgage can be a useful retirement planning tool. Many homeowners simply use the loans to pay off an existing mortgage so they can use that monthly cash for something else, help reduce other retirement debt, or supplement their monthly income.
And research shows that mortgage debt in retirement is significantly more prevalent than it used to be, weighing down the retirement finances of more and more American seniors.
A 2016 study by the LIMRA Secure Retirement Institute found that in 2013, 43% of homeowners ages 65 to 74 had a mortgage, with an average debt of $136,000. Compare that to 1989, when only 11% carried an average mortgage debt of $29,000. These monthly mortgage payments can put a significant drain on your retirement plan.
How your house can help you stay in your home longer.
Another retirement strategy would be to simply sell your home and move into a smaller place at a lower cost. But that goes against the wishes of the vast majority of older adult homeowners, according to The American College of Financial Services’ Home Equity and Retirement Income Planning Survey.
This survey of more than 1,000 people between ages 55 and 75 found that 83% wanted to remain in their current home as long as possible. However, despite this strong desire to “age in place,” only 14% said they’d considered a reverse mortgage, and only 30% of them earned a passing grade on basic knowledge about the retirement planning tool.
Jamie Hopkins, co-director of The American College of Financial Services’ New York Life Center for Retirement Income Planning, says that “advisors and consumers need to start thinking about home equity, including reverse mortgages, as part of the retirement income planning process.”
So, does it work?
Research funded by the U.S. Social Security Administration and published in September 2016 by the Michigan Retirement Research Center of the University of Michigan—How Home Equity Extraction and Reverse Mortgages Affect the Credit Outcomes of Senior Households—found that revolving credit card debt tends to drop when seniors take out reverse mortgages.
The study also found that reverse mortgage borrowers reduced their credit card debt more than borrowers who took out other types of home equity loans, such as closed-end home equity loans, home equity lines of credit, and cash-out refinancing. The upfront cash draws and increased monthly cash flow generated by reverse mortgages helped seniors pay down their credit card debt.
According to the study, seniors who initially withdrew $10,000 using a reverse mortgage reduced their credit card debt by $2,364 in the first year alone. However, additional borrowing resulted in minimal debt paydowns: for every additional $10,000 withdrawn upfront, seniors paid off another $166, and for every additional $100 in monthly cash flow the reverse mortgage generated, seniors paid off an additional $45 in debt for the year.
It should be noted that the study covers reverse mortgages between 2008-2011, a historically low period in financial history. A similar study conducted during a healthy economy may generate even more positive findings.
Ask your financial advisor about a reverse mortgage in retirement.
Taking a loan against your home is a big decision. Ask your trusted financial advisor if a reverse mortgage may be right for you to help pay off your existing mortgage, increase your cash flow in retirement, or set up a line of credit as part of your overall retirement plan to help you meet your goals.
For more information about reverse mortgages, visit the Longbridge Financial home page or consult with a reverse mortgage specialist by calling 855-523-4326.