Reverse mortgages have become normalized in recent years, after decades of developing a dubious reputation among housing and financial experts.
The risk factors linked to reverse mortgages are well known. Billed as providing "guaranteed tax-free income" for Americans 62-years-of-age and older, reverse mortgages can also offer complex contracts, include high (and hidden) fees, deliver often high-pressure sales tactics and produce slippery fine-print language that can trigger a home loss before the owner is ready to leave his house.
Yet reverse mortgages do offer income-generating opportunities, especially for seniors who haven't saved enough for retirement and who can cash in on the liquidity built into their home.
"Seniors are sitting on a mountain of housing wealth," state Karan Kaul and Laurie Goodman, authors of a 2016 Urban Institute study on reverse mortgages. "Homeowners ages 65 and older could access more than $3 trillion in extractable primary residence home equity, but only 6% of senior homeowners are interested in tapping into their home equity to help meet retirement financial needs. At the same time, nearly 37% of senior homeowners are concerned about their financial situation in retirement."
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How can reverse mortgages help cash-strapped U.S. senior homeowners? Mainly, by turning "dead equity" into "live equity," experts say.
"Reverse mortgages are a tool that's specifically helpful to those who have built up equity in their homes, are of the right age -- 62 or older -- and decidedly plan on living in their homes," notes William Flood, a mortgage analyst at FitSmallBusiness.com in New York City. "That last part is key because if the retiree doesn't plan on staying in the home, a reverse mortgage is not an option."
Flood explains that equity in one's home is "dead equity", meaning it produces no income. "In essence, it's kind of trapped," he says. "Reverse mortgages are a way to tap into that dead equity and either pull it out as a lump sum or as a periodic income."
"Reverse mortgages are particularly good for retirees who have good equity in their homes - or may own it outright - but have little monthly income or other retirement assets," Flood adds.
Here's how Flood ranks the upsides and downsides to reverse mortgages:
- The money received is tax-free
- There are no restrictions on how the money can be used.
- Interest is charged only on the money that has been paid out, and the balance can never exceed the value of the home.
- There are no monthly payments like a home equity line or refinance would require.
- The loan balance does not have to be paid until the homeowner dies, sells the property or permanently moves out of the residence.
- Interest rates and fees can be much higher than typical market rates.
- The property value must be maintained - i.e., keep current on taxes, insurance, and upkeep. Failure to do so may lead to the loan being "called" for early repayment.
- There can be complications with inheritance because the loan balance will need to be paid, and in many cases, the lender simply sells the home to repay the accumulated debt.
For most retirees, reverse mortgages should probably be considered as a last resort among all other choices, Flood adds. "People with the ability to borrow, sell assets (including the home) or otherwise invest other assets, may have better choices," he says.
One of the biggest issues is how the reverse mortgage can complicate the homeowner's estate.
"Borrowers almost have to view this as if the bank gets the home in the end," Flood notes. "If, say, parents are intent on passing the family home to a child, a reverse mortgage may create problems or negate that option entirely. In rare situations, with less-than-ethical lenders, the estate may end up being a financial deficiency even after the house is sold. For example, if proceeds from the sale didn't cover the loan, the lender can turn to the estate for the remaining amount."
Yet reverse mortgages can help seniors in more ways than they might think, financial experts say.
"For instance, a reverse mortgage can help retirees when a spouse dies by providing income replacement," says Paul Dilks, a reverse mortgage consultant with southern New Jersey-based Investors Home Mortgage. "If two married retirees are living together and one of the spouses dies, the couple's Social Security payment will be reduced. The reverse mortgage can provide resources that replace the loss in monthly income."
Another benefit comes if retirees are making mortgage payments on their home.
"A reverse mortgage can completely eliminate that burden, and the couple or person can remain in their home," says Dilks. "The reverse mortgage covers the mortgage payment."
Reverse mortgages can help a retiree postpone taking Social Security payments, which can increase their inflation-adjusted income from Social Security by 7.5% per year, each year they wait, says Bill Stack, founder of Stack Financial Services, LLC, in Salem, Mo.
"A reverse mortgage can also help a retiree afford in-home care, which is often preferable to receiving care in a long-term facility," Stack adds.
Even so, potential reverse mortgage consumers need to do their homework first before signing off on any contracts.
"Reverse mortgages are a tool and just like any other tool, need to be used in the appropriate situation," states Phil Reames, president of Reames Financial in Kalamazoo, Mi.
Reames, who has almost 30 years of experience in the financial industry, says he's only recommended a reverse mortgage twice in his career.
"I view it as a tool of last resort," he says. "One client took the advice and one client didn't."
The client who took the advice involved a couple where the husband had dementia and the cost of medical care was overwhelming. "They had Medicaid Part D, but they were hitting the 'donut hole' in June each year, which meant that the couple had to pay way more out of pocket," Reames explains. "They had one adult child who didn't live locally and had no real interest in inheriting his parents' house. He was more concerned that his parents have the money they needed to live on."
Reames organized a family meeting with an elder law attorney. "One of the things I suggested, and the attorney concurred, was that they consider a reverse mortgage to be used to pay some of the extra expenses," he says. "Part of my reasoning is that we did the reverse mortgage during the real estate crash. My clients were able to lock in top dollar on their reverse mortgage before they lost much value. That way the bank took the hit on the lost value of the house from the crash."
The takeaway? Don't opt for a reverse mortgage until you receive some solid professional financial counseling first.
But if you're a homeowner 62 or older, and need the income, a reverse mortgage can fit the bill and provide some much-needed peace of mind in retirement - only if you know what you're getting yourself - and your family - into first.