Reverse mortgages can provide retirees with an additional source of income that will not require them to sell their homes and move into smaller or less amenable residences. These unique products allow users to tap into the equity in their homes and convert it into monthly cash payments that they can use to meet their living expenses.
Financial advisors who have clients who are facing an income shortfall need to consider this possibility as a way to rectify their clients’ cash flows if other alternatives are not available. Reverse mortgages are slowly becoming more accepted in the financial community as a means of achieving a secure retirement. (For more, see: Reverse Mortgages: When They Make Sense.)
How They Work
As their name states, reverse mortgages draw on the equity that is paid into a home and convert it into a monthly stream of cash for the homeowner. There can still be a traditional mortgage on the house when this is done; the house does not need to be paid off in most cases. Then, when the homeowner does sell, the proceeds of the sale will be reduced by the amount of this mortgage. Most reverse mortgages are Home Equity Conversion Mortgage (HECM) loans, which are governed and insured by the Federal Government by the Department of Housing and Urban Development and the Federal Housing Authority.
Both fixed rate and variable loans are available. Fixed-rate loans must be taken as a lump-sum distribution, whereas variable rate loans can be drawn upon as a line of credit. It should also be noted that reverse mortgages are nonrecourse loans, which means that the borrower is only liable to repay the amount of the loan that equals the home’s actual value. For example, if the amount of the reverse mortgage eventually exceeds the value of the home, the borrower is not responsible for the difference.
The perception of reverse mortgages being used as a last desperate resort for retirees who need income is slowly starting to change. The low interest rate environment has left many investors scrambling to find vehicles that can generate the income they need to live on, and reverse mortgages have started to appear as an increasingly attractive alternative. (For more, see: Should Retirees Pay Off Their Mortgage?)
And the government has taken additional steps in the past few years to ensure that the reverse mortgage market remains a viable sector of the loan industry. They have updated their regulations to make the underlying mortgage insurance fund more sustainable, provide increased protection for eligible non-borrowing spouses and make certain that those who use this program still retain sufficient cash flow to pay their homeowners insurance and property taxes as well as maintain their properties. These improvements have been designed to ensure that reverse mortgages are used correctly as viable tools for retirement planning instead of as a means of simply using up the borrower’s assets.
New research that incorporates the actual costs that come with reverse mortgages suggests that they can be an integral part of a carefully crafted retirement plan in many cases. Reverse mortgages ultimately allow users to convert an illiquid asset, their homes, into a liquid one that can help them to meet their living expenses, including their house payments. And some research also suggests that taking out a reverse mortgage earlier in retirement can allow the user’s investment portfolio to grow more, which can help to offset the loss of home equity from the loan.
The Bottom Line
Reverse mortgages are gradually shedding the stigma that the press has attributed to them in past years as this sector of the loan market matures and additional regulations have been instituted. Financial advisors should be sure to evaluate the possible use of these products in their retirement planning, especially for clients who rely heavily on their investment portfolios for their living expenses. (For more, see: How to Get Clients to Save More for Retirement.)