Reverse Mortgages: the What and the How

Many Americans who are close to retirement or have recently retired and have significant home equity may want to consider the use of a reverse mortgage. Per John Salter, associate professor of financial planning at Texas Tech University, “Prior to 2011, reverse mortgages were expensive and really only made sense in the case of financial hardship. Today, the costs can be on par with a traditional home mortgage”.

A good case can be made for using a reverse mortgage to complement your investment portfolio. For example, during investment market downturns, you can pay yourself without selling and locking in investment losses. Read on to find out more about the features of reverse mortgages, and stay tuned for our next blog post on the important uses of a reverse mortgage in a financial plan.

Who can qualify for a reverse mortgage loan? The borrower must…..

Have either no mortgage or a very modest mortgage.
Be age 62 or older.
Meet Federal Housing Authority (FHA) guidelines, similar to most mortgage applications.

What are the key features of the reverse mortgage loan?

Provides access to equity in your primary residence.
Replaces all mortgages and liens.
Lender cannot freeze, reduce, or cancel if borrower meets the terms of the loan.
FHA insured and non-recourse- the borrower never owes more than what house is worth when repaid.
Last as long as you live in the home.
Funds available as a line of credit, lump sum, or monthly payment.
Unused portion of the reverse mortgage line of credit guaranteed to grow despite the home value.

Hypothetical reverse mortgage example using a couple where the youngest borrower is 62 years old and owns a home with a $360,000 value:

Initial reverse mortgage borrowing limit: $190,000 - Depends on borrower age and interest rate, in this case, age 62 and 6.0% rate - the older the borrower and the lower the initial interest rate, the higher the initial available loan limit
Initial mortgage interest rate: 6.00%
Closing Costs: $9,000 - Can be close to zero or higher than $9,000, but it depends on other terms
On-going Costs:
- As of August 2016- 1 year Libor rate (London Interbank Offered Rate and resets monthly)– 1.50%
- FHA annual insurance premium (locked in) – 1.25%
- Lender Margin (locked in at closing) – 3.25% - Can range anywhere from 2.0% to 3.25%

Now, let's talk about who would reap the most benefit from a reverse mortgage and detail a scenario where using this strategy proves extremely useful.

To review, you can qualify for a reverse mortgage if you have either no mortgage or a very modest one, are age 62 or older, and meet the FHA guidelines, similar to most mortgage applications. However, just because you qualify for a reverse mortgage does not necessarily mean it will be a valuable strategy for you. Here are some of the factors that tend to make using the reverse mortgage strategy especially useful:

Relative to your financial situation, you are able to obtain a significant reverse mortgage line of credit. For example, qualifying for a reverse line of credit, which can cover at least 3 years of your basic retirement lifestyle needs.
Given your other retirement income sources, you have a material level of social security benefits. Delaying these benefits significantly increases their value.
Higher tax rates (for example, combined federal/state rate of at least 20%) with a large proportion of your portfolio in pre-tax accounts (IRAs). Reverse mortgage draws are tax-free, while pre-tax IRA withdrawals are taxable.

One of the most beneficial applications of this strategy is to use the reverse mortgage line of credit as a source of funding until delayed social security benefits begin. Delaying Social Security past age 62 to your full retirement age (FRA) increases your benefit by 33%.

Even better, for every year you choose to delay your benefits after FRA, your benefit is increased by another 8%. This means that if your FRA is 66, delaying your benefits until age 70 allows for a 32% increase in benefits for the rest of your life! For many people, choosing to delay benefits until age 70 allows them to break even with taking the earlier FRA benefit by around their late 70s to early 80s. This increase in lifelong benefits can have a large positive impact on your chances of being financially successful in retirement, especially if you anticipate living into your late 80s or even 90s.

It can be emotionally difficult for many people to think about delaying their social security benefits. At retirement, social security benefits provide a steady income stream to help replace some of your lost wage income. Without social security income, you may need to take a much higher percentage withdrawal from your investment portfolio to cover retirement lifestyle spending. Making relatively large value investment withdrawals early in retirement is an uncomfortable feeling for many retirees, especially during periods of significantly down investment markets.

Making use of a reverse mortgage line of credit allows you to delay larger withdrawals from your retirement portfolio by using the tax-free draws to help fund the gap from retirement to social security benefits. And remember, unlike a traditional home equity loan, a reverse mortgage line of credit is always available as long as you remain in your home.