Reverse mortgages can be used to complement a retirement plan or to minimize the impact of an unexpected life event like the loss of a spouse. They can create liquidity out of an illiquid asset—a house.
Reverse mortgages are a type of home loan available to homeowners age 62 and older. The Home Equity Conversion Mortgages (HECMs) program is administered by HUD (the Housing and Urban Development Department) and insured by the FHA (Federal Housing Administration).
Other institutions offer them as well, but not with the same assurances. HUD and FHA provide strict guidelines on borrower qualifications, as well as how payments can be taken out.
A reverse mortgage uses the home as security for the loan, but borrowers don’t make monthly mortgage payments. They must, however, pay property taxes (some municipalities allow seniors to defer property taxes), homeowners’ insurance, HOA fees, and maintenance.
Each month, the loan balance increases as interest and fees are added. As the loan balance goes up, it cuts into the equity of the home. The homeowner(s) or their heirs will eventually have to pay back the loan, often by selling the home or by purchasing it at its appraised value when the loan comes due. As a “non-recourse” loan, the borrower (or estate) is not responsible for any repayment shortfalls.
Many financial experts have started viewing reverse mortgages strategically. A paid-off house is an asset, similar to a retirement portfolio. They see taking money out of the house as no different from spending down a portfolio.
The liquidity provided by a reverse mortgage can be used to:
- delay taking Social Security to age 70 to maximize benefits;
- allow a portfolio to grow in a rising market, instead of using it for living expenses;
- pay the taxes triggered by Roth IRA conversions;
- pay long-term care premiums;
- fund home renovations that allow for aging in place; and
- implement countless other retirement strategies.
Most Americans have a significant amount of their wealth tied up in their homes. A reverse mortgage allows a widow to tap into that equity. However, a reverse mortgage is not a cure-all. Careful consideration is essential before entering into a reverse mortgage agreement.
The above article originally appeared as a chapter in Inheriting Your Spouse's IRA and is reprinted with permission from the author Bill Harris, RMA®, CFP®. No parts of this article may be reproduced without correct attribution to the author of this book.
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