U.S. and global economic volatility due to the COVID-19 pandemic have many retirees (and those close to retirement) worrying how to survive these turbulent times.
Will you have enough assets to maintain your lifestyle and meet retirement spending goals in the face of a possibly long-term bear market?
Traditionally, older adults fund retirement with a mixture of Social Security, pensions, 401(k)s and other retirement and saving accounts.
However, many could be sitting on (or rather, in) hundreds of thousands or even millions of dollars they haven’t considered using: home equity. This source of wealth is often ignored in retirement income planning.
One of the most sensible ways of leveraging home equity in retirement age is through Home Equity Conversion Mortgages (HECM), also known as reverse mortgages. With increased safeguards to protect consumers and lower costs than in the past, reverse mortgages are becoming mainstream financial instruments.
How Does It Work?
Simply put, reverse mortgages enable homeowners age 60+ to borrow up to roughly 50% of their home’s value, depending on their age and that of any spouse also on the loan. Borrowers are guaranteed the right to continue living in their home for the rest of their lives (or until they permanently move out).
Furthermore, while any funds borrowed against home equity continue to accrue interest, all reverse mortgage are non-recourse loans. That means borrowers can never owe more on the loan than what the house is worth when the loan is repaid. If the house has declined in value, the FHA or the lender bears the risk (in part with the help of mandatory mortgage insurance. See below).
On the other hand, if the home should increase in value by the time the owners move out, all remaining equity after paying off the loan belongs to the borrower or their heirs.
In addition, homeowners may pay back the loan without penalty or sell the home at any time (at which point the reverse mortgage lender will be fully repaid).
Higher net worth individuals and families often choose to use reverse mortgages as part of their overall retirement income strategy. It’s not uncommon for these borrowers to make regular payments on their reverse mortgage.
Some choose to make interest-only payments, so their balance doesn’t increase at the rate it ordinarily would.
Others treat a reverse mortgage similar to a traditional loan and make regular monthly payments. With rates on par with traditional mortgages, they are able to borrow money at a low rate of interest and pay it back on their terms, as opposed to the structure of a fixed 15-, 20- or 30-year term.
And some may choose to defer payback until the last remaining borrower leaves the home.
Ways To Make Use Of One
Pay off an existing mortgage: A reverse mortgage can pay off and replace a traditional mortgage loan, reducing the burden of a mandatory monthly payment and resulting in immediate savings — especially helpful in today’s uncertain times.
Standby line of credit: Unlike traditional credit lines, reverse mortgage credit lines are federally insured and cannot be frozen or called due. The unused portion has a guaranteed growth rate of .5% over the current interest rate on the loan, allowing more funds to be borrowed over time. Even if the home decreases in value, the line of credit remains and continues to grow.
This offers an excellent insurance policy against market fluctuation, and a tax-free source of money that can be used as a buffer in a down market.
The strategy in turbulent times would be to draw funds from the credit line instead of drawing on other assets (such as selling stocks when they’re down). Thus, a reverse mortgage credit line can limit the need to make portfolio withdrawals, protecting and preserving retirement accounts.
Multiple payout options: Reverse mortgage proceeds may be accessed in a lump sum, in the form of an annuity (a lifetime payout known as “tenure”), through equal payments over a fixed period of time (known as “term”), or through a combination of these options.
While reverse mortgages can be based on fixed interest rates, the line of credit, tenure and term payouts are available only on adjustable interest rate options.
Interest rates on reverse mortgages are on par with traditional mortgage interest rates. Rates are negotiable and vary from lender to lender.
The “index rate” is the standard rate that varies depending on market interest rates. It is not controlled by the lender. The rate charged on your loan can increase or decrease depending on whether the index increases or decreases.
The margin rate is the interest percentage that is added to the index by the lender. This rate is not adjustable, meaning that after loan origination, the margin stays the same throughout the loan term, regardless of what the index may change to. It is also negotiable.
Cost Of A Reverse Mortgage
HUD counseling: To obtain reverse mortgages, borrowers must undergo mandatory counseling with a third-party HECM counselor approved by the U.S. Department of Housing and Urban Development. Typically charged at $125, this counseling addresses the lending process, benefits, drawbacks and eligibility requirements.
Home appraisal: Appraisals run on average $450 to $550 and can vary depending on the size, age and condition of your home. They are ordered through an independent appraisal management company.
Third-party closing costs: Expect to pay typical mortgage fees for loan recording, credit report and title insurance. These fees could vary and are negotiable. Ask for an itemized fee breakdown.
Mortgage Insurance Premium (MIP): There is an initial mortgage insurance premium of 2% of the home’s appraised value. Over the life of the loan, you’ll also pay an annual MIP that equals 0.5% of the outstanding mortgage balance. (This federally-backed insurance helps protect lenders in the event the value of the home drops over the life of the mortgage.)
Loan origination fee: Lenders may change a loan origination fee ranging from zero to $6,000 depending on your home value. This fee is negotiable and can vary among lenders. Most costs may be financed into the loan.
An important note on costs: Reverse mortgage borrowers must also continue to pay their property taxes, insurance and maintain the home to comply with loan guidelines.
As with any financial product or service, education is paramount. Discuss the options with a knowledgeable professional before committing.
This article originally appeared in the April 2020 Edition of The Beacon Newspaper.