One of the dilemmas of home ownership in retirement is whether to keep the home as a residence or sell it to provide additional retirement income. On one hand, a home owned free and clear in a desirable location may allow for a higher standard of living at an affordable price. On the other hand, selling the same property and down-sizing might mean greater net cash flow.
The resolutions to this dilemma are not limited to staying in the home or selling it. In some circumstances, it may be possible to continue living in the same house while also drawing an income from the accumulated equity through an arrangement known as a reverse mortgage.
A reverse mortgage (also known as a home equity conversion mortgage, or HECM) is a home equity loan for older homeowners that does not require monthly payments. Instead, the loan is due only when borrower sells the home, moves out or dies. Repayment is often made by the sale of the property, with any excess equity remaining either with the borrower or heirs.
The very first reverse mortgage was written in 1961 by Nelson Haynes, a banker in Portland, Maine, to allow the widowed wife of his high school football coach to stay in her home after losing her husband. Over the next five decades, the arrangement has become formalized, and today, most reverse mortgages are transacted under guidelines issued by the U.S. Federal Housing Administration. Among the standard provisions:
- A homeowner seeking a reverse mortgage must be 62 or older.
- The home must be used as a primary residence.
- The home must either be owned outright or have a low mortgage balance that can be paid off with proceeds from the reverse mortgage.
- There are no restrictions for how the money from a reverse mortgage can be used.
- Depending on the terms of the reverse mortgage, funds can be received as a lump sum, a fixed monthly payment, a line of credit, or a combination of the above.
- 2015 FHA guidelines require reverse mortgage applicants to undergo a financial assessment that includes an income assessment, credit check, and third-party consultation.
Since the lender will not receive any payments of interest or principal until some point in the future, the amount available for loan is a percentage of the home’s equity. This percentage is calculated in consideration of several factors, including the borrower’s age, the loan interest rate, and the anticipated future value of the property. Generally, the older you are and the more valuable your home, the more money you can get.
With no required mortgage payments, interest on the loan accrues each month. This increasing balance can eventually grow to exceed the value of the home, particularly if the home’s value declines, or the borrower remains in the home for a long time. However, at the end of the mortgage the borrower (or the borrower’s estate) is generally not required to repay a balance in excess of the sale value of the home.
Considerations and Caveats
Just because you’re a retiree with substantial equity in a home doesn’t mean you should take out a reverse mortgage. Steven Sass, from the Center for Retirement Research at Boston College, says a reverse mortgage makes sense for people who:
- Don’t plan to move.
- Can afford the cost of maintaining their home.
- Want to access the equity in their home to supplement their income or have money available for a rainy day.
There are many ways a reverse mortgage could enhance retirement. The equity could provide additional income, consolidate other debt and increase cash flow, serve as a reserve fund for medical expenses or travel. But any consideration of a reverse mortgage also must address other potentially challenging factors.
Whether a borrower can reasonably expect to continue living in the home is a critical consideration. Could failing health, or changing social connections to friends and family prompt a move? If the borrower is married, or being cared for by an adult child, would the death of the borrower mean an eviction for a survivor due to the sale of the house to satisfy the reverse mortgage balance?
Besides the human issues, there are also “carry costs” to consider. Even if the home is owned free and clear, there are still taxes, insurance, maintenance, and the possibility of major repairs to consider. One of the stipulations of a reverse mortgage is that the property must remain in good condition, so a future sale can repay the debt.
Spending the Equity and Keeping the House
There may be opportunities to integrate a reverse mortgage with other pieces of your financial program such that the retiree can spend the equity, yet still leave the house to his/her estate. From a tax and investment perspective, drawing additional retirement income from a reverse mortgage might be preferable to liquidating assets that would incur capital gains or income taxes. These “unspent” assets can be held in reserve to repay the reverse mortgage when the borrower moves or dies, restoring the home to the estate. Another variation of the same strategy is coordinating a permanent life insurance policy with a reverse mortgage. At the borrower’s death, proceeds from a life insurance policy could be used to repay the outstanding debt.
Even if you’re not ready to retire, this discussion may prompt you to consider how you intend to use your home equity. Do you want to increase your equity or pay off an existing mortgage before retirement? Is there an advantage to positioning a reverse mortgage as a “last asset,” one that can be accessed later in retirement when the payout would be highest? These are questions that can only be evaluated in the context of your other financial assets and unique circumstances