Reverse mortgages don’t have a great reputation.
Many financial planners have long derided the loans, which allow homeowners over the age of 62 to get cash in exchange for the equity they have in their property, as a last resort for retirees who’ve run out of other financial options. The homeowners can get the money via either a lump sum, a line of credit or monthly payments, and they don’t need to pay it back until they (or their heirs) sell the property.
While that may appear straightforward, the Great Recession proved that these financial products are riskier than they seem. A 2015 report by the Consumer Financial Protection Bureau found that many ads for reverse mortgages left consumers with misconceptions about the loans. After the most recent housing bust, reverse mortgage borrowers who could no longer pay the insurance and taxes on their homes were forced out of their homes and found that they had already depleted their home equity, which had served as their de facto nest eggs.
In response to those issues, the Federal Housing Authority, which backs most reverse mortgages (also known as home equity conversion mortgages), implemented some new regulations to tighten the lending criteria for borrowers.
Under the new rules, borrowers can only take out up to 60 percent of the total mortgage amount in the first year, which helps prevent them from using up their assets all at once. Lenders must also assess whether a borrower will be able to cover the cost of maintenance, taxes and insurance on the property. “That seems like a no-brainer, but it wasn’t required previously, and folks were getting reverse mortgages, using up all their equity, and then finding themselves unable to afford to stay,” says Margot Saunders, a lawyer with the National Consumer Law Center.
The amount you’re able to borrow depends on your age, with older borrowers qualifying for larger loans. The new regulations also allow borrowers’ spouses to remain in the home even after the borrower dies, regardless of whether the spouse was named on the reverse mortgage. Borrowers must also undergo financial counseling in which a professional explains exactly how the loan works and helps evaluate individual circumstances.
While the rules for reverse mortgages have changed, so has the stigma surrounding them. A growing number of financial planners have begun advocating the use of reverse mortgages not as a loan of last resort but as a sensible part of a holistic approach to retirement planning, particularly for the many Americans who are now approaching their post-work years with little or no retirement savings but a large home. A recent University of Georgia study found that consumers taking out reverse mortgages were more likely to have a higher net worth than those who didn’t use them. And three quarters of those who have a reverse mortgage say that it has improved their quality of life, according to a new study by from researchers at the University of Ohio.
About half of households age 55 or older have no retirement assets at all, and those with retirement accounts have median savings of just over $104,000 in them — not nearly enough to cover the costs of a decades-long retirement. However, more than half of those who don’t have retirement accounts do own a home, and a fifth of them own their home free and clear.
“Having a reverse mortgage in place can provide some more flexibility, and a cushion to give you some breathing room if an unexpected expense crops up,” says Keith Gumbinger, vice president of mortgage information web site HSH.com.
Despite their increased appeal, reverse mortgages still have some drawbacks, though. They carry high fees, so they’re an expensive way to tap into your home equity. If you’re ever planning on moving out of your house, or if you hope to leave it to your heirs, using a reverse mortgage would likely leave you little equity by the time you do move out.
For borrowers who qualify for lower loan amounts, a better option may be to find another way to unlock the equity built up in the home.
“You have to decide whether it’s really worth it to stay in the house,” says Leslie Tayne, a financial attorney specializing in debt. “Instead, you could sell the house, take the money out, and move somewhere that’s more affordable.”
Consumers interested in a reverse mortgage should weigh the pros and cons with a financial planner. It’s legal to use the proceeds any way you’d like, but here are a few uses that might make sense from a financial perspective:
- Paying off a traditional mortgage. Seniors can use a lump sum reverse mortgage to pay off an existing mortgage, freeing up their cash flow as they head into retirement.
- Creating an emergency fund. One of the appealing aspects of establishing a reverse mortgage line of credit is that if you don’t use it, the value of the line actually grows each year. Unlike a traditional line of credit, a reverse mortgage line of credit cannot be cancelled if you lose your job or the value of your home declines.
- To help with strategic portfolio withdrawals. Having access to home equity funds via a reverse mortgage gives retirees some flexibility to avoid having to draw down portfolios in a down market. In addition, reverse mortgage funds aren’t taxed, so they can provide an income stream that won’t affect taxable income.
- For aging-in-place home renovations. Older retirees who are planning to stay in their home can use the funds from a reverse mortgage to install universal design elements throughout the property to make it more comfortable to live there.
- To delay taking Social Security. Some planners suggest that retirees can use reverse mortgage proceeds to delay claiming Social Security in order to maximize that benefit.
Current market conditions also mean that consumers may be able to access larger loans — a result of today’s relatively high home values — and relatively low interest rates. “This would be a good time to lock in a reverse mortgage,” says Steve Sass, program director for the Financial Security Project at the Center for Retirement Research.