Ten years ago, many financial advisors dismissed reverse mortgages out of hand. Their reasoning was that reverse mortgages, which give homeowners an advance on their home equity and allow them to delay repayment until the home is sold, were risky and only for people in desperate financial straits.
However, several safeguards have led some advisers and researchers to reevaluate reverse mortgages and explore when and how they might be used in financial planning. For example, the Reverse Mortgage Stabilization Act of 2013 prevents homeowners (in most cases) from taking all of their equity at once, which could reduce the default rate on reverse mortgages by half. Instead, homeowners with reverse mortgages must wait at least one year to take a lump sum.
Other regulations require homeowners to show that they are able and willing to pay their property taxes and home insurance. In 2014, almost 12% of reverse-mortgage borrowers in the federally insured Home Equity Conversion Mortgage (HECM) program defaulted on their property taxes or homeowners insurance. Another regulation provides protection for the nonborrowing spouse.
It is important to note that in the HECM program the government assumes some of the risk for the borrower. An HECM borrower is typically not responsible for losses associated with negative equity. If the balance on the reverse mortgage exceeds the value of the home, the federal insurance covers the difference.
So what are some of the best ways to utilize a reverse mortgage? One involves borrowing enough of the equity in the home to pay off an existing mortgage. It is estimated that over 60% of reverse-mortgage borrowers have used the proceeds from the reverse mortgage for this purpose. Why is this strategy beneficial? A report by Harvard University’s Joint Center for Housing Studies found that nearly 40% of seniors age 65 and older carry a mortgage today, more than double the number who did so in 1992. Using a reverse mortgage to pay off a forward mortgage can improve a household’s monthly cash flow. Of course, it is essential to avoid overleveraging oneself. If the homeowner uses the borrowed money to, say, buy an expensive new car, then he or she has not only taken on more debt but also lost the financial cushion of having equity in a home.
Another way to use a reverse mortgage is to establish a line of credit through the HECM program. This can make more sense than taking a lump sum and holding the money in reserve. The unused portion of a line of credit grows over the years, providing the homeowner with access to more money. This money can be used in a variety of ways, such as protecting savings, increasing income in retirement, and even protecting retirement funds from fluctuations in the financial markets. How? In a bear market, the homeowner can borrow funds as needed through the line of credit instead of withdrawing money from his or investment portfolio. When withdrawals from a portfolio are made during down markets, the losses are locked in and less money is available for growth when the markets eventually rebound. By borrowing from the HECM line of credit instead, the portfolio has a better chance to recoup losses from a bear market.
Reverse mortgages are not for everyone. To find out if one is right for you, contact us today for a personal consultation. You can learn more about the HECMs, visit https://www.benefits.gov/benefit/709.