It has been a while since we addressed the topic of reverse mortgages here on the AgingOptions Blog. This type of mortgage, also called an “HECM” (which stands for home equity conversion mortgage), can be a potential game-changer for retirees who need a steady flow of tax-free income. But there are downsides to reverse mortgages as well, and that mix of pros and cons makes it imperative that you do your homework before signing on the proverbial dotted line.
In this recent article from The Motley Fool, financial planner Matt Frankel gives a pretty balanced answer to the question, “Should you use a reverse mortgage to retire?” There are certainly situations in which the response is a solid affirmative – but for others, an HECM could be a costly mistake. Let’s take a look and Frankel’s pros and cons.
Starting With the HECM Basics
“A reverse mortgage could provide much-needed cash flow, but there is more to the story,” Frankel writes. “A reverse mortgage can provide income for retirees, either as a lump sum or fixed monthly payment.” But as we said above, the “should I or shouldn’t I” question has no simple answer. “For many retirees,” says Frankel, “a reverse mortgage can be a great financial tool, but it isn’t right for everyone.”
The big challenge many retirees will face is ensuring adequate income over the long haul of retirement. “If you’re retired, or getting close, you might be thinking of how much income you’ll have after retirement and whether it will be enough,” says the article. “Even with Social Security and retirement savings accounts, many retirees might be faced with a substantial drop in income after leaving work for good.”
Aimed at qualifying homeowners 62 and older, a reverse mortgage works in the opposite way of a traditional mortgage. “Instead of you making payments to a bank and gradually building equity in your home,” says Frankel, “a bank makes payments to you in exchange for your home equity.” Sounds good – but the devil (as they say) is in the details.
Advantages of a Reverse Mortgage
Since most older Americans view the equity in the home as somehow sacrosanct, never to be tampered with, why would someone opt to tap into that asset pool? The biggest reason is for guaranteed extra retirement income. But, as The Motley Fool article makes clear, that’s not the only reason why an HECM might be attractive in our golden years.
- Financial flexibility: There are several ways in which a retiree can choose to receive income from a reverse mortgage. Some opt for a fixed monthly payout while others borrow a lump sum. The best option, Rajiv tends to believe, is to use an HECM to open a line of credit that you can draw from if and when you need it. With most reverse mortgages, that line of credit actually grows over time, adding to your borrowing power.
- Keep your home: “Sure,” says Frankel, “you could sell your house in retirement to access your equity, but then you have to move. With a reverse mortgage, you get to stay in your house for as long as you want.” This is true even if you outlive your equity. “Even if a reverse mortgage results in a bank owning all of the equity in your home, you continue to live there, and don’t owe anything to the bank for as long as you’re alive, unless you decide to sell the home.” (Of course, in that case there will be no equity left for your heirs, either. See below.)
- Tax-friendly income: “Payments you receive as a result of a reverse mortgage are not taxable income,” says Frankel. “In the eyes of the IRS, it is simply a return of money you already have.”
- Non-recourse loan: This is an important benefit of most reverse mortgages. A “non-recourse loan” is backed only by the home itself, not by any of your other personal assets. “No matter how much a borrower receives from a bank and how large the loan balance becomes,” says the article, “the amount due can never be more than the value of the home.” This protects your heirs from owing your bank more than your home is worth after you’ve passed away.
Potential Drawbacks to Consider
So much for the good news – now for the bad news. “There’s no such thing as a perfect financial product,” Frankel writes, “and reverse mortgages certainly are not an exception.” He lists these drawbacks to keep in mind as you evaluate a reverse mortgage option.
- You lose your home equity: Frankel calls this “the biggest reason to not get a reverse mortgage.” After all, you’ve spent decades building up the equity in your home, and if you live long enough with an HECM you could potentially die with no equity left at all. “You’ll still be able to keep living in your home,” he writes, “but a reverse mortgage might not be the best option if you want to leave your home to your heirs.” (In our personal experience, we know that the reverse mortgage holder has to be satisfied first before your estate can be distributed, so your heirs will have to address this issue.)
- Lots of hefty fees: Another drawback of HECM loans is the expense of setting one up. “Reverse mortgages have relatively high closing fees compared with other types of loans,” says Frankel. “Plus, when interest rates are high, your equity can start to disappear at a rapid pace.” While most of those fees will get rolled into the loan itself, the upfront cost will add to the amount your heirs will have to cover when you’re gone.
- Other home expenses are your responsibility: An HECM doesn’t absolve you of the costs and headaches of home ownership. “You’re still responsible for paying property taxes, insurance, and maintenance on your home,” says Frankel. “If you fall behind on these expenses, the bank could force you to sell.”
So – Is a Reverse Mortgage Right for You?
When it comes to making a recommendation, Frankel leaves the ball squarely in the retiree’s court. “The bottom line is this,” he writes: “Whether a reverse mortgage is right for you or not depends on your unique situation. For example, if you aren’t worried about leaving your home to your heirs and don’t mind the closing costs, a reverse mortgage can be a great way to build retirement income. On the other hand, if you like having your home equity as a financial safety net and you have other borrowing options, such as a HELOC (home equity line of credit), it might not be the best option.”
We’ve asked Rajiv Nagaich of AgingOptions about reverse mortgages many times before, and his advice is always the same: don’t make the decision in a vacuum. “I urge you to get good objective counsel before you decide,” he warns. “Don’t just talk to somebody who sells reverse mortgages for a living! Are they going to answer your questions objectively? Probably not!”
Rajiv also suggests you consider how long you plan to stay in your home before taking out an HECM. “If this is the home you plan to stay in for the rest of your life, then fine, a reverse mortgage might make sense. But,” he adds, “if there’s a reasonable chance you’ll be moving in four or five years, there are other borrowing options that will serve your needs a lot better and save you many thousands of dollars.” If you have questions about this topic, reach out to us at AgingOptions.
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(originally reported at www.fool.com)