I first learned about reverse mortgages approximately 20 years ago. I was working for a major Wall Street brokerage firm, and it was common practice for financial product wholesalers to visit our offices and pitch their product to us, hoping that we would introduce it to our clients. Reverse mortgages were a pretty new concept back then. There was little to no regulation protecting consumers, costs were extremely high, and there were horror stories of how elderly folks were losing their homes, or their spouse was being forced to move. The whole idea felt a bit slimy. Needless to say, I never introduced the idea to any clients back then.
Fast forward 20 years. The reverse mortgage industry has grown up, and cleaned up, quite a bit over the last couple of decades. There is now regulation designed to protect the borrowers, costs have come down (although they are still not inexpensive!), and reverse mortgages have become a bit more mainstream. They are still not a widely utilized financial tool, but more people know about them now, mainly from celebrity endorsements in television commercials. So, am I ready to endorse them and start recommending them to clients? I’m closer now than ever before, but I still have my reservations.
An Income Source in Retirement
First, let’s go over the basics of how a reverse mortgage works. With a traditional mortgage, you borrow money secured by your property and then make payments. With a reverse mortgage, you receive money, either in a lump sum or as monthly payments, and are not required to make payments. The reverse mortgage, which increases over time based on the interest rate, is paid back when the property owner dies, moves, or sells the home. You must be 62 years old to qualify for a reverse mortgage, and you must go through financial counseling to make sure you understand the product.
In what situations would a reverse mortgage be appropriate for you or a family member? It can provide access to funds for folks who could use an additional source of income in retirement. Often, a retiree’s largest asset is their home, and in many cases, it is fully paid off. A reverse mortgage can allow the retiree to tap the wealth they have built up in their home, increasing their cash flow.
When someone retires, they typically begin making distributions from their investment accounts. Making distributions from an account puts stress on the portfolio. If the markets are behaving, the stress on the portfolio is limited. However, when the markets are going through a difficult time and the value of the account is declining, the distributions become more stressful to the portfolio. This is where I think a home equity conversion mortgage (HECM), a reverse mortgage that gives the borrower a line of credit to draw on, can be particularly helpful. While the portfolio is under pressure, the cash flow that is needed can be drawn on the home’s value instead of the investment account.
Considerations to Be Aware Of
The previous two paragraphs discussed the pros of a reverse mortgage and how it can be helpful. What about the cons or other things to watch for?
The main negative with a reverse mortgage would be the large amount of fees involved. There are origination fees, mortgage insurance fees, appraisal fees, title insurance, and other various closing costs—and, of course, the interest rate. The costs vary depending upon the specifics of the situation, just like any mortgage. In addition, the fees are not usually paid out of pocket but are rolled into the loan amount.
Another important consideration is that if you should ever move out of the home, say to a long-term-care facility, the loan becomes due once you have been out for a year. Finally, the reverse mortgage is a lien on your home, which means that there will be less money to leave to your heirs when you pass away. If passing on the home is not important, this becomes less of an issue.
It’s important to clarify some popular misconceptions about reverse mortgages. Many people think that a reverse mortgage can cause them to be evicted from their home. This is not true. You make the decision on when and if you leave the home. The mortgage is not due until your home is not your primary home any longer.
It’s also a myth that the reverse mortgage can eventually exceed the value of your property, leaving your estate with a large bill to pay. A reverse mortgage is what’s known as a “non-recourse” loan, which means that you, or your estate, will never owe more than the appraised value of the home when it is due.
While reverse mortgages have come a long way over the years, and have been gaining acceptance in the financial planning community, I believe that they are appropriate in only certain situations. If you are considering a reverse mortgage, it is important to make sure you fully understand this tool. As with any financial product or service you are considering, there are costs and benefits. Make sure you are aware of both.