Reverse Mortgages 101

For some of you, the first thing that comes to mind when you hear “reverse mortgage” is Tom Selleck pushing them on late night TV commercials. Regardless of whether you were convinced by Magnum P.I. or thought him a snake oil salesman, it’s worth uncovering the truth about them.

Similar to many other financial decisions you consider in retirement—buying an annuity, delaying Social Security, moving to Florida—the “right” decision depends entirely on your circumstances.

What follows is an introduction to reverse mortgages: what they are, how they work, who should consider one, and who shouldn’t bother.

What is a reverse mortgage?

A reverse mortgage is a type of loan that allows homeowners who are at least 62 years old and own their home to convert a portion of their home’s equity into cash.

Instead of you making payments to the lender, the lender pays you through a variety of payout options, including monthly installments, a lump sum, a line of credit, or some combination of those three.

The loan becomes due and is payable when you die, sell the house, or no longer live in it as your primary residence.

How it can be a useful retirement tool

For many households, home equity represents the largest portion of their net worth. Yet, few retirees even consider the value of their home as an option to provide retirement income, or if they do it's only as an absolute last resort.

This is a mistake. Reverse mortgages can be an outstanding way to enable a higher level of spending in retirement and/or potentially increase the legacy you leave to your heirs. They can be used in a number of different circumstances:

If you own your home free and clear
If you currently carry a traditional mortgage and want to replace it with a reverse mortgage
If you are looking to purchase a new home that will be your primary residence

And there’s a variety of benefits or strategies that can be deployed:

Eliminate an existing mortgage payment to free up monthly cash flow
Supplement other income with a monthly installment payment, lasting for a specific term or for as long as you’re alive in the home
Replace taxable distributions from a qualified account with (generally) tax-free monthly payments
Reduce portfolio withdrawals to leverage upside growth potential
Mitigate sequence of return risk (withdrawing from your portfolio during market downturns)
Provide income for the “bridge period” when delaying Social Security benefits
Act as an emergency fund for spending shocks (i.e., health expenses, in-home care, etc.)

Why they’ve gotten a bad rap

As I alluded to at the top, reverse mortgages carry a negative connotation in some people’s minds.

Of course, there are anecdotes of people choosing (or in many cases, being convinced) to use a reverse mortgage irresponsibly. But simply because there are ways to use it incorrectly doesn’t negate the ways it can be used as a valuable tool!

What I want to address are many of the misconceptions that exist about them. Here are those that I think are most relevant:

The lender owns your home. A reverse mortgage does not transfer ownership of your home to the lender. This is simply not true.
It can’t be refinanced. It’s a loan like any other and can be refinanced, depending on the borrower’s financial situation.
The heirs will lose the home. Heirs can inherit the home and they can pay off the reverse mortgage or sell the house to repay the loan. They are not obligated to repay the loan personally if the loan balance exceeds the home value.
It’s bad for your heirs. Your heirs likely will inherit less home equity but may consequently inherit more in the way of outside assets.
It’s only for people who are desperate. In fact, the ideal time to put on a reverse mortgage is as a proactive measure that’s part of a retirement income plan, not as a last resort.
They’re too expensive. Initial costs for opening a reverse mortgage have come down dramatically since the past. However, upfront fees do exist and are generally higher than a traditional mortgage. But those costs come with unique benefits, namely, not being required to make payments!

Who should and shouldn’t consider a reverse mortgage

It’s worthwhile for you to consider a reverse mortgage if:

You desire to “age in place” or stay in your home for as long as possible
Your home equity represents a significant portion of your net worth
Your outside assets are mostly qualified accounts, meaning that you must pay taxes on distributions
You’re carrying a mortgage obligation into retirement but still have significant home equity

On the other hand, a reverse mortgage likely does not make sense for you if:

You plan to move out of your house at some point in the near future
You will be tempted to access the home equity for improper/irresponsible use
Your outside income and assets are more than enough to meet your retirement spending needs
You have insufficient equity in your home

Final Thoughts

The goal of retirement income planning is to provide for your spending needs and legacy goals in the most efficient way possible. This means considering all sources of income and all assets. Failing to factor your home equity into this equation is foolish.

There exists a tool that was designed to utilize that equity in order to provide a richer retirement than you might otherwise be able to experience. The only question left to answer is whether or not that tool is right for you.

Photo by Kostiantyn Li on Unsplash