Reverse Mortgages That Work
A path to provide retirees with financial flexibility and security.
Many homeowners in or near retirement face a quandary. Their wealth is tied up in their home—two-thirds of the average retiree’s net worth is home equity—yet they’d rather not tap that wealth by selling their house and downsizing.
One versatile solution is a reverse mortgage. It lets you stay put, ditch your mortgage payment (if you still have one) and tap your home equity. The money you borrow can be used however you like—to supplement retirement income, to renovate your home or to cover health care costs, for example. Divorcing spouses can use a reverse mortgage to, say, help one spouse keep the house and the other buy a home. With a reverse mortgage “for purchase,” you can even buy a retirement home. The loan comes due when the last surviving borrower dies, sells the home or leaves for more than 12 months due to illness. You’ll never owe more than the value of your home when you or your heirs sell it to repay the reverse mortgage.
The National Reverse Mortgage Lenders Association figures that only about 3% of eligible borrowers have one. Many financial advisers and consumers continue to think of reverse mortgages as loans of last resort. But some potentially detrimental features have been corrected. And over the past several years, financial researchers have found that a reverse mortgage taken as a credit line early in retirement can grow, providing steady income or buffering financial shocks, even for well-heeled borrowers. For example, tapping a line of credit could allow you to avoid taking a distribution from your investment portfolio when it has lost value, or it could cover the cost of long-term care, says Wade Pfau, director of retirement research at McLean Asset Management, in McLean, Va.
Bill and Maureen Deller of Marana, Ariz., near Tucson, took out a reverse mortgage in mid 2017 as a kind of insurance policy. The couple, both in their mid seventies, have a “reasonable” retirement portfolio, says Bill. They also collect Social Security and have long-term-care insurance. The Dellers considered a home-equity line of credit but chose a reverse mortgage after discussing it with their financial adviser. Their home appraised for $280,000, which qualified them for a reverse mortgage with a line of credit of nearly $172,000. “We really don’t need the reverse mortgage financially,” says Bill, “but it makes us feel more comfortable that if we need it, we’ve got it.”
Options for taking the money
Your borrowing power depends on your age (or the age of the younger spouse), the value of your home and current interest rates. With a rate of 5%, a 62-year-old borrower can qualify for an initial payout (the principal limit) of 52% of the home’s value (up to the current Federal Housing Administration limit of $636,150), says Shelley Giordano, chairwoman of the Funding Longevity Task Force, which focuses its research on the role that home equity and reverse mortgages can play in planning for retirement income.
Because, in effect, you’re receiving loan advances, not income, the money is tax-free. It won’t affect what you pay for Medicare, how your Social Security benefits are taxed or your eligibility for Medicaid. You or your heirs can deduct interest on a limited amount of debt when the loan is repaid. To offset the up-front cost, plan to keep your home for several years or more. If you use little or none of the money, it’s similar to paying premiums for insurance that you never need. You can prepay the loan balance without penalty whenever you like.
Borrowers have several payout options, depending on their goals. A line of credit offers the most flexibility. You can borrow the maximum amount for which you qualify during the first two years, tap the line periodically to supplement income, or hold the line in reserve. You’ll incur interest only on the outstanding balance. Meanwhile, the untapped portion of the line compounds at the same rate at which interest is charged on any balance. If interest rates rise, more interest will accrue on the outstanding balance, but the untapped portion of the line will grow in tandem. That’s another reason to take a reverse mortgage with a line of credit sooner rather than later. Over many years, the line of credit can increase to far more than the original amount.
Retirees will have the greatest probability that their resources will outlast them if they avoid taking money (or take less) from their investments in a down market, especially early in retirement, according to research by Pfau and others. In a month or year when your investments have lost value, you could take withdrawals from the line of credit instead. When your investment portfolio has recovered, you can begin withdrawing money from your investments again, possibly repaying the line of credit and rebuilding its insurance value.
Borrowers who want guaranteed income can also choose fixed monthly payments—possibly in addition to the line of credit. You can take fixed payments in one of three ways.
A term payment will provide fixed monthly payments for a certain period. You could use it as an income bridge to, say, postpone taking Social Security until age 70, when you’ll qualify for the maximum Social Security benefit. However, if you take term payments, you don’t get any more money after the fixed period. Older seniors who anticipate needing in-home care for just a few years may benefit by taking a reverse mortgage with term payments just before they begin care, says Steve Resch, a vice president of Finance of America Reverse.
A tenure payment provides fixed monthly payments based on your age (and a life expectancy of 100), and payments continue until the last borrower dies, sells or leaves the home. The term or tenure payment will remain the same even if your loan balance grows beyond the value of your home.
A reverse mortgage with tenure payment can be a compelling alternative to an immediate fixed annuity if you plan to stay in your home for life, says Pfau. Whereas an annuity requires a large up-front payment taken from other assets, a reverse mortgage requires only that you cover the up-front costs, which you can pay from the loan proceeds. The payment calculation doesn’t penalize women or couples for their longer life expectancies compared with single males, as annuities do. Plus, payments from the reverse mortgage are tax-free, whereas annuity income may be taxable.
A modified term payment or modified tenure payment combines either payment type with a line of credit. This approach provides guaranteed income and flexible access to a growing line of credit. You’ll continue to receive the term or tenure payment even if you use the entire line of credit.
The least-flexible form of payout is a lump sum. This is a one-and-done deal. You can take part or all of your principal limit to, say, renovate your home, buy long-term-care insurance or pay the tax bill if you convert traditional IRAs to Roth IRAs. But because you incur interest from day one, “it makes no sense to put the money under your mattress or invest it in something else,” says Patricia Whitlock, a loan originator in Brookhaven, N.Y.
Shop for the best terms before you choose
Before you shop for a reverse mortgage, it’s a good idea to discuss with a financial adviser how one would fit into your retirement plan. Look for an adviser who has earned the retirement income certified professional (RICP) designation from the American College of Financial Services (search for one at Designationcheck.com).
An adviser can discuss options for payouts with you, or you can run what-if scenarios with the reverse mortgage calculator at the Mortgage Professor website. See how much you qualify for based on various factors and receive a summary of competitive offers from participating lenders. You can give a lender your contact information to follow up with you, or you can use the summary to compare offers from other lenders. To find lenders in your state, visit Reversemortgage.org, the website of the National Reverse Mortgage Lenders Association, and click on “Find a Lender.” Look for a loan officer who is a certified reverse mortgage professional.
Get at least three quotes, and make sure each one shows a selection of margins and illustrates how your choice affects your up-front cost and payout. The Federal Housing Administration says lenders can charge an origination fee equal to the greater of $2,500 or 2% of your home’s value (up to the first $200,000), plus 1% of the amount over $200,000, up to a cap of $4,000 for homes valued from $200,000 to $400,000 and $6,000 for homes worth more than $400,000. But the FHA program doesn’t require lenders to charge the maximum, and if a lender says it does, move on. You’ll also owe fees for third-party services (such as an appraisal, title search and insurance, and inspection), which can run $1,300 to $2,500 or more. You can pay up-front costs from the loan proceeds or out of pocket—say, to stay under the 60% threshold so that you avoid a higher insurance premium.
Lenders charge a fixed interest rate on a lump-sum payout and a variable rate on all other types of payouts. Rates are based on an underlying index—typically the one-month or one-year LIBOR—to which lenders add a margin of 2.5 to 4 percentage points. In general, the higher the margin, the lower the origination fee. You can negotiate a credit against your closing costs if you agree to accept a higher margin. A typical interest rate on lump-sum payouts is 5%. Draws from a line of credit have variable rates, recently ranging from 5% to 6.5% using the one-month LIBOR.
Some loan officers’ compensation may be linked to the amount that you borrow immediately, so they may suggest taking more money sooner. Don’t fall for that. Plus, reverse mortgage lenders can’t legally sell you other financial products, such as annuities.
Keeping your end of the bargain
You must maintain your home and pay property taxes, hazard insurance premiums, and homeowners association or condo dues, or you’ll risk defaulting on your loan. If the lender determines you can’t handle those costs, it will set aside funds from your payout in an escrow account and pay those bills.
After the borrower leaves the home, lenders must allow an eligible nonborrowing spouse or committed partner to stay. That could still leave survivors in the lurch because they can’t take any more money from the reverse mortgage, but they must still keep up with taxes, insurance and maintenance. You’ll never owe more than the value of your home when it’s sold to repay the reverse mortgage. If your home sells for more than you owe, you or your heirs keep any leftover equity. If your heirs want to keep the home, they can refinance the reverse mortgage, or they can pay the outstanding debt or 95% of the home’s appraised value, whichever is less.
What you need to know
To be eligible for a reverse mortgage, borrowers must be at least 62 years old, named on the title of the home and live in the home for more than half of the year. The maximum payout, or principal limit, for which you’ll qualify depends on your age (or that of a younger co-borrower or a nonborrowing spouse, who must meet certain criteria to be eligible), as well as the current interest rate and the appraised value of your home, up to a maximum of $636,150. Some lenders offer larger, “jumbo” reverse mortgages.
You must get financial counseling to ensure that you can meet your obligations as a borrower. To find a housing counselor certified by the Department of Housing and Urban Development, call 800-569-4287 or search for “HUD Approved Housing Counseling Agencies” online. A session costs $125 to $250 over the phone or in person.
If you have a mortgage, you must pay it off from the loan or other sources. You can withdraw no more than 60% of your principal limit in the first year, unless you need more to pay off existing mortgage debt or make repairs required by the lender. Reverse mortgages are insured by the Federal Housing Administration and, at closing, you’ll pay an initial FHA mortgage insurance premium equal to 0.5% of the appraised value of the home if you take 60% or less in the first year, or a 2.5% premium if you take more than 60%.
You’ll accrue annual mortgage premiums at a rate of 1.25% of the amount you borrow, and interest charges will accrue on any outstanding balance—though no principal or interest payments are due until the home is sold.