Retirees often look to investments such as bonds and certificates of deposit for steady income. But they might do well to also sign up for a type of loan that is typically considered a last-resort option for cash-strapped seniors and is often the subject of late-night TV pitches by fading stars.
Despite a bad reputation, reverse mortgages, which let retirees tap the equity they have built up in their homes, have become a better deal in recent years. And they can be valuable as part of your overall financial plan for retirement, says researcher Wade Pfau, author of a new book, Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement.
“Used strategically, a reverse mortgage can greatly improve the sustainability of your retirement income,” says Pfau, a professor of retirement income at the American College of Financial Services.
For instance, you might use a reverse mortgage to provide income for several years while you delay claiming Social Security--or you could tap a reverse-mortgage line of credit to minimize withdrawals from your portfolio in a stock-market downturn. You should consider signing up for a line of credit early in retirement even if you don’t think you will ever need it.
First, a few reverse mortgage basics: These loans do not have to be repaid as long as you still live in your home. To qualify as a borrower, you need to be at least age 62 and own your home as a primary residence. You can take the loan as lump sum, as payments over different periods (including your lifetime, as long as remain in the home), or as a line of credit that doesn’t have to be repaid until you move or die.
The loans are more costly than regular mortgages and complex, and in the Great Recession some borrowers lost their homes when they could no longer afford to pay the upkeep. But new federal rules governing these mortgages went into effect in 2013, and a lot has changed for the better, says Pfau. At the same time, industry competition is helping to lower fees.
Still, these loans aren’t for everyone. To help you sort it out, Pfau offers three key things to know:
Reverse mortgages have become less risky but harder to get.
Most reverse mortgages today are federal Home Equity Conversion Mortgages (HECMs), loans made by private lenders under a program administered by the U.S. Department of Housing and Urban Development. And they have tighter requirements than before, to avoid the default and foreclosure problems of the recession.
Among the changes: Loans are capped at a percentage of the home’s current appraised value, up to $625,500. The percentage of equity you can tap might range from 50% to 70%, but will vary widely based on your age and interest rates. You can take out only up to 60% of the home’s value in the first year, which is a lower percentage than before. (This calculator will give you an estimate of the amount you can borrow.)
The new rules also allow a spouse who isn’t named on the loan to remain in the home as long as it’s still his or her primary residence. (Previously, some non-borrowing spouses faced eviction when the borrower had to leave the home or died.)
To avoid foreclosure problems, borrowers must meet new financial assessment requirements to ensure they can continue to afford property taxes and other home costs. “These loans should no longer be delayed until needed as a last-resort option,” says Pfau. “Now they are being targeted toward middle-class retirees who have some financial assets.”
These loans can provide flexible retirement income.
After comparing different scenarios using reverse mortgages with other forms of retirement income, Pfau found that they improved the sustainability of the retirement portfolio and resulted in larger amounts for heirs. “Reverse mortgage loans help cushion market risk, and they reduce the need for investment portfolio withdrawals,” he says.
A reverse mortgage can also provide flexibility, since you can switch to different payout schedules based on your needs. For example, a so-called term payment, which lets you borrow over a set period of time, can be used as a source of income that allows you to delay claiming Social Security, says Pfau. That’s a valuable option, since each year you delay claiming, your benefit increases by 6.5% to 8% a year until age 70.
Another option is to take out a line of credit early in retirement, even if you don’t need immediate income. That can be a smart strategy, says Pfau, because your line of credit will grow over time, giving you more resources to tap later in life, if you need the money.
“If left to grow, the line of credit may surpass the home’s value before it is used,” Pfau says.
There are lower-cost loans available, but you’ll have to shop around.
One of the biggest drawbacks to reverse mortgages has been their upfront costs, which can run to thousands of dollars. You can still find expensive loans, but overall fees are coming down, according to Pfau. Some lenders charge just $125 in total upfront costs, he says, with a 0% origination fee and credits to cover other closing expenses. But be prepared to call around, since reverse mortgage shopping hasn't made a move online yet. And make sure to clarify whether you will be paying fees out-of-pocket or if they’re being added to your loan balance.
As more boomers head into retirement, the tools for comparing reverse mortgage deals are likely to improve. "Reverse mortgages may be a niche market right now, but it's like the early days of figuring out Social Security claiming strategies," says Pfau. "As people realize the need, the information will become much more available."