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Option of Last Resort -OR- Something Else?
By Rick Kahler CFP® MS ChFC CCIM
Like most financial planners, I generally recommend not thinking of your home as a part of an investment portfolio or a source of retirement income. One possible exception to this rule, for medical professionals to consider, is a reverse mortgage.
Lenders
Lenders which are FHA-approved can offer Home Equity Conversion Mortgages, or HECM’s. These are insured by the U.S. government and allow homeowners age 62 and older to borrow against the equity in their homes. When the homeowner dies or moves out, the property is sold to repay the loan. Any equity left over belongs to the owners or their heirs. Any outstanding loan balance must be forgiven by the lender.
Reverse mortgages may be useful for elderly people in good health who have limited income or assets but who are living in paid-for homes.
Until now, I have viewed them as options of last resort. But, a new report by financial planner Michael Kitces CFP® has given me some cause to re-evaluate that position.
Link: http://www.kitces.com/index.php
Disadvantages
- One major disadvantage of reverse mortgages is that the income uses up the equity in the house. Seniors who take out reverse mortgages too early risk spending most of their home equity to cover living expenses. As long as they can stay in the house, that’s no problem. If they have to move, however, they will have to pay rent or long-term care costs. Without income from the sale of their house, they may be left with little except Social Security to pay their bills.
- A second disadvantage has been high upfront fees. A new option described by Kitces, however, significantly lowers those costs. The HECM Saver option eliminates the upfront mortgage insurance premium of 2%. This would drop the costs of a reverse mortgage on a $500,000 home from $17,000 to $7,000. The tradeoff is a lower lump-sum or monthly payment.
Typical Uses
- The most typical use of a reverse mortgage is to tap into home equity to pay the bills when all other means of support become exhausted. Instead of selling or refinancing, the homeowners can choose to stay in the home and receive monthly payments for life. They don’t have to sell the property until they can no longer continue to live in it.
- Another way to use a reverse mortgage is to refinance an existing mortgage. This can not only eliminate the monthly payment, but if there is enough equity in the home it can also provide a monthly income or a lump sum payment.
Example
Kitces uses the example of a 70-year old couple paying $1000 a month for a $175,000 traditional mortgage on a $450,000 property. A $175,000 reverse mortgage would eliminate the $1,000 payment. Assuming the net principal limit for the borrower was $250,000 on the property, they could use the reverse mortgage to extract an additional $75,000 of equity. They could receive this in a lump sum payment, create a $75,000 line of credit, or receive lifetime monthly payments based on the $75,000.
Let’s assume this couple’s monthly expenses, including the mortgage payment, are $5,000. They receive $1,500 a month from Social Security and withdraw $3,500 a month from their $600,000 investments. The total $42,000 annual withdrawal is an unsustainably high 7% of their portfolio.
The reverse mortgage would eliminate the $1,000 mortgage payment and reduce the investment withdrawal to $2,500 a month. This totals $30,000 annually, a more sustainable withdrawal rate of 5%. Investing the $75,000 of excess proceeds would produce additional monthly income and reduce the withdrawal rate even further. Using a reverse mortgage in this way makes sense if the lost home equity is offset by an increase in investment assets.
Assessment
We’ll look at some other reverse mortgage options another time, so stay tuned to this ME-P, and subscribe today!
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Filed under: Financial Planning, Mortgage Electronic Registry System, Retirement and Benefits | Tagged: FHA, HECMs, Home Equity Conversion Mortgages, Michael Kitces, Rethinking the Reverse Mortgage Paradigm, reverse mortgages, rick kahler |
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Update
Last week on the above ME-P, I explored how you could use a reverse mortgage to produce an income for life while allowing you to live in your home until your death or you move out. We also considered the possibility of using a reverse mortgage to refinance an existing mortgage, thus eliminating a house payment and possibly creating additional monthly income. Now, I’ll look at a few more creative ways to use reverse mortgages, as suggested by financial planner Michael Kitces.
While most of us think of a reverse mortgage as a way to unlock equity in a current home without having to sell it, Kitces points out that another use for a reverse mortgage is buying a new home. While the buyer will need a larger than normal down payment due to the lower lump sum limits of a reverse mortgage, this technique can be used to increase cash flow while downsizing a home.
Here is how this might work. A couple owns a house worth $300,000 with a $125,000 first mortgage. The monthly payment is $800. They would like to downsize to a smaller home costing $200,000. One option is to sell the current home and use the proceeds of $175,000 to buy the new one, obtaining a traditional $25,000 loan with a $200 monthly payment.
Another possibility would be to use $100,000 of the sale proceeds as a down payment on the new home and finance the remaining $100,000 via a reverse mortgage. The balance of the proceeds of $75,000 could go into a portfolio and generate $300 a month for life.
This eliminates the house payment and also increases their monthly income. The result is an increase in available cash of $1,100 a month over staying in the current home and $500 a month over selling the home and obtaining a traditional mortgage. The owners would get to live in the property until death or they moved out. They also would still have $100,000 of equity in the house if they did need to sell it.
Still another option, which I touched on last week, is to supplement your monthly cash flow with a reverse mortgage long before you’ve depleted all your assets. By using a reverse mortgage early on, homeowners may be able to preserve and extend their liquid reserve.
Here is an example Kitces gives of how it might work. A 72-year-old couple spends $6,000 a month and collects $3,500 from pensions and Social Security. The remaining $2,500 a month comes from their $400,000 portfolio, which is an unsustainably high withdrawal rate of 7.5%.
They have a $400,000 home with no mortgage. By obtaining a HECM Saver reverse mortgage they could receive $1,300 a month for life. This would reduce their withdrawal from their portfolio to $1,200 per month, a sustainable 3.6%. This could conceivably preserve their investment nest egg for the remainder of their lives..
Because payments from a reverse mortgage do not increase with inflation, and because they use up home equity for current living expenses, a reverse mortgage is always a strategy to be evaluated carefully. Thus you need to be careful not to begin receiving reverse mortgage payments too early. The youngest you can be to apply for a reverse mortgage is age 62, but in most cases it may be best to wait until you are in your 70s or 80s. The longer you wait, the higher the monthly payment.
A reverse mortgage is not for everyone. Used wisely and appropriately, however, it may make a difference in extending your standard of living for many more years and possibly for the rest of your life.
Rick Kahler CFP® MS ChFC CCIM
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Reverse Popularity
Reverse mortgages — which allow homeowners to borrow against the value of their homes as described above — have been around since the early 1960s. But, they have grown in popularity; most recently. Why?
TV commercials with celebrities such as Henry Winkler, Robert Wagner and Fred Thompson promoting reverse mortgages are rampant during weekends and late night viewing hours.
http://bottomline.msnbc.msn.com/_news/2012/03/16/10722646-more-seniors-use-reverse-mortgages-to-raise-cash
Linus
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The New Reverse Mortgage Magic
Rick – Now, seniors can buy a new home with a large initial deposit, but no future mortgage payment.
http://registeredrep.com/wealthmanagement/the_new_reverse_mortgage_magic_418/index.html?NL=RGR-06&Issue=RGR-06_20120418_RGR-06_136&YM_RID=marcinkoadvisors%40msn.com&YM_MID=1305971
Any comments?
Barbara
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How to Correctly Use Reverse Mortgages for Elderly Clients
Rick – Any financial advisor worth his or her proverbial salt is familiar with reverse mortgages [or are they?] and how their often unique arrangements can allow house-rich but cash-poor seniors to afford to remain in their primary residences.
http://registeredrep.com/wealthmanagement/how_to_correctly_use_reverse_mortgages_424/index.html?NL=RGR-06&Issue=RGR-06_20120425_RGR-06_503&YM_RID=marcinkoadvisors%40msn.com&YM_MID=1307506
But, are these products right for MDs?
Monty
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Reverse mortgages still confusing
More younger retirees pulling equity out of their homes in a lump sum, raising concerns about what will happen when they get older.
Reverse mortgages are likely to become more popular as baby boomers age, but the products remain confusing, according to a report by the new Consumer Financial Protection Bureau.
http://realestate.msn.com/blogs/listed-loans.aspx?post=b2a0436c-1e07-4e93-a0b5-8f7137938f35
So, not so fast on the RMs
Clyde
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Reverse Mortgage Madness
Don’t bet the farm on them
http://wealthmanagement.com/retirement-planning/reverse-mortgage-madness?NL=WM-08&Issue=WM-08_20120810_WM-08_236&YM_RID=marcinkoadvisors%40msn.com&YM_MID=1330454
The reverse mortgage industry also recently launched a new education initiative aimed at helping seniors better understand the product.
http://www.reversemortgage.org/
Monty
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REVERSE MORTGAGE SCAMS
Many people’s life savings are tied to the equity in their homes, a prime target for thieves. Reverse mortgages are a popular way for seniors to take cash out of their homes without having to move. Scams related to this sometimes-useful tool come in many forms, from fees hidden in the fine print to failure to disclose the consequences of unexpected default.
So, buyer beware.
Malcolm
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The New Retirement Plan That Banks Don’t Want Seniors Knowing
You may be surprised to find out how much money seniors can receive through a Reverse Mortgage.
Still unknown to many, this brilliant retirement method is helping senior citizens across the country by eliminating their monthly mortgage payments and putting cash in their bank account through what’s called a “Reverse Mortgage Loan”. You can bet that your current mortgage holder might not be too thrilled about this, since they would be losing your business.
So while your mortgage holder may secretly hope you don’t find out about how a Reverse Mortgage works, an innovative online tool has been setup to educate homeowners about Reverse Mortgage loans and how much you are eligible to receive. If eliminating your monthly mortgage payments, generating additional retirement cash, all while being able to live in your home during your lifetime sound good to you, it may be better to act now while it is still on your mind.
Millions of seniors across the country are in financial stress with high mortgage payments and other medical bills. Many are unable to work, while they are in need of extra retirement income. A Reverse Mortgage loan is often a great solution to eliminate your monthly mortgage payments and generate retirement cash.
What Exactly is a Reverse Mortgage and How Does it Work?
A reverse mortgage is essentially a loan. You are borrowing against your home equity. You can get a lump sum amount, line of credit or get monthly checks. However, unlike traditional mortgages, with a reverse mortgage you do not have to pay back the money you have borrowed as long as you are living in the home.
Reverse Mortgages are ideal for you if:
•You’d like to eliminate your monthly mortgage payment, or if you struggle with bills every month.
Could you use an extra $600-$1500 per month?
•You plan to stay in your home for the rest of your life.
•You could use the extra money that it provides you.
•You are 62 years or older and have 50% or more equity in your home.
Downsides of a Reverse Mortgage
Although a Reverse Mortgage sounds like a no-brainer, there are many things to consider when exploring this retirement method. Here are a few:
Interest: Since a reverse mortgage is a loan, it does accumulate interest. But there are no monthly payments due on a reverse mortgage. So the amount you will eventually have to pay back does grow larger over time, but the loan isn’t due until you decide to sell your home or when both you and your spouse have died. (To avoid foreclosure, borrowers must keep property taxes & insurance paid up and keep the property in good repair.) The loan repayment amount will never exceed the value of your home.
Estate Value: Your estate value may lower over time. Something to take into consideration if you plan to leave your assets to children.
Not Enough Cash Can Be Tapped: If you have a lot of home equity, you might be frustrated that a Reverse Mortgage only enables you to use some of it. The HECM loan rules will evaluate your equity using a maximum home value of $625,500, even if your home is worth more. However, your actual loan amount is determined by a calculation that uses the appraised value of your home, the amount of money you owe on the home, your age and current interest rates.
NewRetirement.com
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Reverse Mortgages
“The profits are significant, the oversight is minimal, and greed could work to the disadvantage of seniors who should be protected by government programs and not targeted as prey,”
said Dave Stevens, CEO of the Mortgage Bankers Association until last year and a commissioner for the Federal Housing Administration in the Obama administration.
Larry
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RVs
Reverse mortgages are very dangerous. They are positioned as a wide ranging appropriate retirement income option. They are not … Annuities are positioned the same way.
Like annuities, reverse mortgages serve a very specific purpose. It’s definitely oversold and can be confusing especially to elderly prospective clients. And so, a TON of homework / research would need to be done to ensure it was an appropriate choice.
JOE
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