Improve Cash Flow And Your Financial Plan
You might not have heard much about reverse mortgages outside of AARP or daytime tv commercials. They mostly fly under the radar for three main reasons; they're not heavily promoted, they suffer from social stigma, and most financial advisors aren't familiar with their financial planning utility.
However, reverse mortgages have evolved in recent years, so much so that most investors should at least consider looking into them as part of an overall retirement income strategy.
HOW THEY WORK
At the most basic level, a reverse mortgage allows a borrower to use home equity to supplement retirement income. The premise is that distributions augment retirement income sources already in place.
Reverse mortgages are issued by a bank to a homeowner aged 62 or older. The bank provides the borrower with cash flow. There are no specific stipulations regarding how the distributions should be spent. As the borrower receives distributions, a loan balance accrues against the home's equity.
When the borrower sells the home & moves, transitions to assisted living, or passes away, the bank gets their money back via sale of the home. Alternatively, if the kids want to keep the house, any reverse mortgage balance can be paid with life insurance death benefits, bank accounts, leftover investment assets, or any combination of those. If the home sells for more than what's owed, the borrower, or the beneficiaries managing their estate, keep any difference.
FACTS
- Youngest borrower must be at least 62.
- Enrollees keep the deed to their house.
- There are caps on how much the enrollee can initially borrow based on age, home value, and rate.
- Rates are similar, but usually a tad higher, than a conventional mortgage.
- Distributions are considered loan advances and therefore not treated as taxable income.
- Distributions do not impact Medicare premiums or the taxation of Social Security benefits.
- Repayments are not required but can be made voluntarily or at any time during the loan with no prepayment penalty if the borrower chooses.
- Reverse mortgages come with government insurance designed to protect the borrower if the home doesn't sell for as much as what was borrowed.
- Loan interest is deductible in the year repayments are made if the borrower itemizes on their tax return.
- Special reverse mortgage programs exist for condo owners & high value homes, usually worth > $1M.
- Borrowers do not need a fully paid off home to initiate a reverse mortgage.
MISCONCEPTIONS
Reverse mortgages underwent significant evolutions in 2013, 2014, and 2015, making them more affordable, cost effective, and flexible*. However, myths persist from years of negative publicity and lingering social stigma.
Here are a few general types of misconceptions**:
The Bank Gets Your House. False. You and/or your estate retain ownership, deed, and title. The bank's role is limited to any outstanding loan balance.
You Must Make Monthly Repayments. No. The whole point of a reverse mortgage is to create an income stream you don't have to repay until you move or pass away.
Your Kids Don't Get The Home. Not so! However, your kids don't want your home. They already live where they want to live. Second, your kids can use your bank & brokerage assets or life insurance death benefits to pay off the loan and move into your house if that's what they really want.
You Need To Own Your Home Outright. Not true. You can convert your mortgage to a reverse mortgage at retirement. Goodbye monthly payments. Hello newfound money for a more sustainable retirement!
A High Level Of Income Is Required. No. You must demonstrate an ability to cover normal home related expenses such as insurance and property taxes. You've been doing this for years anyway.
Reverse Mortgages Are Only A Last Resort. Historically, sure, but quite the opposite today. Reverse mortgages create additional retirement income helping you achieve financial goals such as retiring earlier than anticipated, reducing taxable income, delaying Social Security payments, and reducing stress on your investment portfolio.
You Could Owe More Than Your Home Sells For. This could happen, which would normally be a risk if it weren't for government insurance built into all reverse mortgages. A small portion of your loan expenses cover this cost to bridge any potential gaps when the home is ultimately sold.
Your Friends Will Judge You. Maybe, but not after you explain the benefits. Besides, no one but your kids even need to know until you die. You probably won't care what people think at that point anyway.
It Just Seems Weird After Spending All Those Years Paying Your Mortgage Off. Nah. This is just your own mental constraint. Get over it. Start thinking of your house as a potential income producing asset as well as a familiar place to call home.
If you'd like to do your own homework, here is a list of resources to sift through.
Reverses Mortgages, How To Use Reverse Mortgages To Secure Your Retirement, Pfau.
Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income, Sacks & Sacks.
Understanding the Line of Credit Growth for a Reverse Mortgage, Pfau.