Econintersect: Reverse mortgages have been a possible part of retirement planning for many years. They are a way for retirees to use equity in their home as a source of income payments. The plans have often functioned in the form of an annuity with fixed monthly payments for the life of the reverse mortgage agreement or with a fixed sum payout at the closing. Various options for the structure of reverse mortgages – some are discussed below. Now a new type of reverse mortgage is available that operates more like a home equity line of credit and can be drawn against or repaid depending on circumstances and need.
Here is a general description of s reverse mortgage from the National Reverse Mortgage Lenders Association:
A reverse mortgage is a loan available to people over 62 years of age that enables a borrower to convert part of the equity in their home into cash.
Reverse mortgages were conceived as a means to help people in or near retirement and with limited income use the money they have put into their home to pay off debts (including traditional mortgages), cover basic monthly living expenses or pay for health care. There is no restriction on how a borrower may use their reverse mortgage proceeds.
The loan is called a reverse mortgage because the traditional mortgage payback stream is reversed. Instead of making monthly payments to a lender (as with a traditional mortgage), the lender makes payments to the borrower.
The borrower is not required to pay back the loan until the home is sold or otherwise vacated. As long as you live in the home, you are not required to make any monthly payments towards the loan balance, but you must remain current on your tax and insurance payments.
The Federal Trade Commission provides more specific definitions of the three types of reverse mortgages:
- single-purpose reverse mortgages, offered by some state and local government agencies and nonprofit organizations
- federally-insured reverse mortgages, known as Home Equity Conversion Mortgages (HECMs) and backed by the U. S. Department of Housing and Urban Development (HUD)
- proprietary reverse mortgages, private loans that are backed by the companies that develop them
Single-purpose reverse mortgages are the least expensive option. They are not available everywhere and can be used for only one purpose, which is specified by the government or nonprofit lender. For example, the lender might say the loan may be used only to pay for home repairs, improvements, or property taxes. Most homeowners with low or moderate income can qualify for these loans.
HECMs and proprietary reverse mortgages may be more expensive than traditional home loans, and the upfront costs can be high. That’s important to consider, especially if you plan to stay in your home for just a short time or borrow a small amount. HECM loans are widely available, have no income or medical requirements, and can be used for any purpose.
According to an article in Financial Advisor, nationally known financial advisor Harold Evensky says that a new form of HECM is now approved that does not operate with either a fixed regular payment or a one time settlement. This new reverse mortgage arrangement gives the home owner the option of when and how much at a time is withdrawn from the home equity. And the arrangement also allows the homeowner to repay withdrawals when that fits the individual’s plan.
Evensky says that the great value of the new structure is that it can enable a retiree to greatly reduce the cash “on-hand” because the availability of the HECM permits the retiree to otherwise avoid having to sell investments at what might be an inopportune time in the market. Here is how the situation is described by Financial Advisor for the reduction of income that might occur as the result of a bear market:
The use of HECM Savers can reduce the cash reserve that Evensky would recommend a retiree hold from two years of living expenses to six months because there is the HECM money to draw on if needed.
A HECM is also substantially less expensive than reverse mortgages have been, thereby providing a ready pool of capital to tap into when needed at a relatively low cost, he says.
“When markets regain their strength, the mortgage can be paid back,” Evensky adds. “Our studies indicate this will significantly increase the survivability of the portfolio in retirement.”
Evensky also believes in what he calls a five-year mantra, since five years is roughly the equivalent of an economic cycle. Here is a quote from Financial Advisor in that regard:
“Simply put, we don’t believe anyone should be investing funds they may need in the next five years. Otherwise, they may have to sell at the wrong time,” he says. “We replenish the cash-flow reserve as we manage the investment portfolio.
“If someone has $1,000,000 in savings and indicates they want to buy a second home for $100,000 three years from now, we would suggest they carve out $100,000 and put it in cash-flow reserve comprised of short-term bonds and cash and invest the remaining $900,000,” Evensky explains.
The new HECM structure replaces the need for such carve-outs.
One final note: Another article today in Registered Rep discusses another way that a reverse mortgage can be used in retirement. It can be used to purchase a home at a big discount. Here is what that article said:
Let’s say a 65 year-old couple wants to buy a $350,000 home in Palm
Beach, Florida, using a reverse mortgage to make the purchase.
According to the calculator available at allrmc.com, they would have to
come with $139,730 of their own money—about 40% of the purchase price.
The total initial fees would be $12,680 which, when combined with the
borrowed amount of $210,270, would bring the total of the loan to
That amount will accrue at 4% annually (the current going rate) until
both members of the couple die, or move out of the place for more than
a year. Then the house is sold by the lender.
If the selling price is less than the balance owed, the couple will owe
nothing. But if the sales proceeds exceed the balance owed when the
house is sold, they (or their heirs) will receive the difference.
What is the downside of this arrangement? If the buyer lives in the hime for many years there may be nothing left at the end. Because interest is accruing the entire time the balance on the mortgage can become very large, greater than the home can be sold for. Here is how Registered Rep describes the situation:
The primary risk to using a reverse mortgage to buy a home is due to the interest that is accruing on the borrowed amount.
The longer the owners live and remain in the home, the more likely it is that the amount “owed” on the reverse mortgage will exceed the purchase price, eliminating whatever equity the owners established at the time of purchase.
Take the aforementioned couple buying the place in Palm Beach. If they stay in the place for twenty years, the calculator at allrmc.com says that by that time the loan balance will be about $635,656.
Even if the value of their home rises at, say, 3% per year for those twenty years, at that point it will be worth $637,454. If the couple then gives up the home to the lender, they will have lost the $139,730 they put up as the initial down payment.
- Evensky: New Choice May Preserve Portfolios, Lower Cash Reserve Needs (Karen DeMasters, Financial Advisor, 18 April 2012)
- What is a Reverse Mortgage (National ReverseMortgage Lenders Association website)
- Reverse Mortgages: Get the Facts Before Cashing in on Your Home’s Equity (Federal Trade Commission website)
- The New Reverse Mortgage Magic (Registered Rep, 18 April 2012)