What is a reverse mortgage?
As explained here, a Home Equity Conversion Mortgage (HECM) “reverse mortgage” is a way for senior homeowners to access the equity in their house. A retiree in need of additional cash can obtain this cash through a traditional mortgage or a home equity loan. However, these options require monthly payments, increasing the retiree’s expenses.
Unlike these traditional loan options, a reverse mortgage does not require monthly repayments.
The worst way to use it
Part of why reverse mortgages get a bad rap is because they can make an already unpleasant situation worse.
Reverse mortgages are often viewed as a “last resort.” If a retiree runs out of money but has a paid-off house, a reverse mortgage can provide a lifeline to liquid funds. But failing to keep up with property taxes and homeowner’s insurance means the house can be foreclosed.
In this situation, a bad scenario already exists. Is the reverse mortgage to blame? No. Little could have been done to improve the outlook.
The best way to use it
How should a reverse mortgage be used and why should everyone at least consider it as an option? Consider these steps.
1. Open a reverse mortgage line of credit early in retirement.
The minimum age to get an HECM reverse mortgage is 62. The earlier you get a reverse mortgage, the better. Why?
- The line of credit limit grows every year. Naturally, starting the mortgage earlier means more time for the line of credit to grow.
- Low interest rates increase the attractiveness of reverse mortgages. We are currently experiencing historically low interest rates. The lower the interest rate, the higher the amount available to you.
2. Let the line of credit grow.
This is key. Starting early means access to a larger amount later. Even if you don’t need the equity now, starting the process soon ensures credit will grow.
So, why does the line of credit grow?
Say you qualified for a $100,000 reverse mortgage line of credit and took out the full amount right away. You now have a $100,000 loan balance. Remember, you aren’t required to pay down the loan balance. If you choose not to, the loan balance increases every year at a variable interest rate.
But any amount you don’t advance and keep as a line of credit also increases every year. This ensures you have a source of future income that is guaranteed to grow
3. Be smart about using the line of credit.
After getting a reverse mortgage, you have several options when deciding how to use the funds. Consider these:
A volatility buffer
Chances are you will be drawing down your invested assets in retirement. Volatility can wreak havoc on your portfolio when occurring in tandem with withdrawals. A reverse mortgage isn’t tied to the stock market. You can take your retirement income from the line of credit instead of your investments when the market is in a downturn.
In this strategy, your reverse mortgage is a “volatility buffer” because it’s not correlated with the stock market. It softens the blow that a volatile market would otherwise have on your portfolio. The end result is a higher probability of retirement success.
Plus, you can still leave a larger legacy for your heirs, even after accounting for a loan balance. The loan balance can be overshadowed by a higher portfolio value thanks to the volatility buffer.
A tool of last resort
Contrary to opening the reverse mortgage later in retirement when it’s needed, being proactive by opening it early ensures an “emergency fund” line of credit with guaranteed growth. This can be used to fund unexpected expenses or make upgrades to your house as you age in place
A term or tenure payment
Instead of letting your line of credit grow, you can start monthly payments that are guaranteed, much like an annuity or pension.
A tenure payment is an option that will give you equal monthly sums for as long as you live in your house—without a lifespan cap. Even if the loan balance later on exceeded the value of your home, the payments will continue.
Likewise, a term payment also provides equal monthly payments. However, a term payment is scheduled for a limited number of years (i.e., 5, 10, 20 years).
Not everyone should get a reverse mortgage. However, everyone should consider it. Again, the best way to utilize an HECM reverse mortgage is to open the line of credit early in retirement.
It doesn’t matter if you don’t need it for the equity in your house now. What you are doing is giving yourself the best probability of success through retirement. You have one shot at retirement with an unknown future. A smart reverse mortgage strategy is simply a tool to add more certainty to your retirement plan.
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