For many Americans, their home is the biggest asset, and the one they have invested the most in throughout their lives. In fact, home equity now represents more than two-thirds of total wealth for the average 65-year-old American Couple1. Reverse mortgages work by allowing homeowners to tap into their home’s equity while continuing to reside there well into retirement years.
A reverse mortgage is a type of mortgage tool designed for borrowers aged 62 and greater to help manage cash flows in retirement. It allows homeowners to convert a portion of their home equity into cash without having to sell their home or make monthly mortgage payments. The amount that can be borrowed is determined by the age of the borrower, the value of the property, and current interest rates.
Homeowners retain ownership of the home and are required to occupy the home as their principal residence. They are also required to pay property charges such as property tax, homeowners’ insurance, HOA dues, and maintain the property. The loan proceeds can be distributed in multiple ways, and the loan does not have to be repaid until the borrower dies, permanently moves out, or sells the home.
There are several ways to receive funds from the proceeds of a reverse mortgage. Borrowers can set up tenure payments which provide a fixed monthly distribution for the life of the loan. Term payments are fixed monthly distributions for a designated time period. Lump sum distributions are when borrowers receive a total amount when the loan closes. A line of credit can be set up which gives borrowers future access to funds. Funds can be distributed in any one of these methods or in a combination of various methods.
The most common reverse mortgage program is insured by the Federal Housing Administration (FHA) and is called a Home Equity Conversion Mortgage (HECM). This program has maximum loan limitations. For borrowers whose loan amounts exceed the FHA limits, proprietary products are available for loan amounts up to $4,000,0002.
Surviving spouses of a married couple who have jointly obtained a reverse mortgage are allowed to continue to live in the home while not being required to make any mortgage payments3.
When the borrowers move out, sell, or pass away, the loan becomes due. If the property is sold at that time, the loan and accrued interest are paid off, and the borrowers receive the remainder of the equity. If the borrowers pass away, the heirs inherit the property. They then have 6 months to pay off the loan, whether by selling or refinancing the home. Two 90 extensions are available if extra time is needed. Note that the estate retains the equity of the property. When the loan is paid off, the loan servicer also issues an IRS Form 1098 for deductible home mortgage interest expense4. If the value of the home is not sufficient to pay off the mortgage balance, neither the borrower nor the estate is required to pay the difference of the mortgage balance5.
Many misconceptions exist about Reverse Mortgages6. It is important to accurately understand the program to make the best possible decision of whether to obtain a Reverse Mortgage and which options are best for you.
Reverse Mortgages can be used in many useful and strategic ways7. These uses include supplementing monthly cash flow, eliminating the payments associated with current mortgage debt, reducing the distribution rate of the portfolio8, hedges against inflation, providing resources to pay for future healthcare needs, and mitigating sequence of returns risk thus maximizing the investment portfolio9, to name a few.
While not perfect for everyone, a Reverse Mortgage can offer financial solutions for retirees in a myriad of ways. It is important to consult with an experienced professional who takes the time to understand a borrower’s specific needs, in addition to having a detailed understanding of the nuances of a Reverse Mortgage. Financial advisors should also be consulted to develop a well-thought-out plan on how to incorporate home equity into the overall retirement financial strategy.
Footnotes:
2. See HECM and Proprietary Reverse Mortgage Differences and Similarities
3. See Spouses and Reverse Mortgages.
4. See Tax Strategies
5. See Non-Recourse Nature of a Reverse Mortgage
6. See Myths About Reverse Mortgages
7. See Reverse Uses of Funds
8. See Managing Portfolio Longevity Using a Reverse Mortgage
9. See Sequence of Return Risk
