When used appropriately, a reverse mortgage can be an effective tool for managing retirement income. If you are not planning to bequeath your home to beneficiaries, a reverse mortgage can provide an income stream to supplement your cash flow and protect your portfolio during market downturns. In the 80s and 90s, reverse mortgages were often used as a last resort and had a bad reputation due to high fees, overly complex arrangements, and scams. But fast forward to the current day where reverse mortgages are better regulated and insured, and rules are in place to prevent these kinds of abuses. For a senior whose wealth is tied up in an illiquid asset such as their home and who has insufficient income streams to provide a comfortable retirement, then a reverse mortgage could be a great choice.
What is a reverse mortgage? Basically, a reverse mortgage is the opposite of a conventional mortgage. Instead of turning the principal portion of your mortgage payment into home equity, you turn your home equity into money that you can use. A reverse mortgage allows you to borrow against your home equity and receive the proceeds in several ways: a lump sum payment, fixed monthly payments for as long as you live in the home (known as a tenure plan), fixed monthly payments for a term of your choosing (known as a term plan), or a line of credit. You can also combine one of the fixed monthly payment options with the line of credit. The loan balance is due when you die, move permanently, or sell the home.
How does it work? The lender makes a payment or payments to you, and you agree to pay the lender back with the equity you have in your home after you leave the home. Of course, you pay interest on the proceeds, but that interest is rolled into the loan balance. The upshot is as long as you are living in your home, you don’t have to pay anything back. You do continue to be responsible for property taxes, insurance, and home maintenance while receiving the proceeds. This is because you remain the owner, and keep the title to your home. Overall, the reverse mortgage increases your debt and decreases your equity.
An attractive feature of a reverse mortgage is that when it’s time to pay the loan back, you never owe more than the value of your home. If the amount you owe is greater than the value of your home, for example if home prices fall or you live longer than expected, your other assets are protected. In this scenario, the lender is reimbursed by the Federal Housing Administration (FHA) mortgage insurance program that you pay into over the life of the loan. If the amount you owe is less than the value of your home, you or your heirs keep the difference.
Here are the eligibility requirements:
- 62 years of age or older
- Own your home outright, or be able to pay off the remainder of your mortgage with the proceeds of the reverse mortgage
- Occupy your home as a principal residence
- Must be a single-family home, a two-to-four-unit home where you occupy one unit, a U.S. Department of Housing and Urban Development (HUD)-approved condominium, or a manufactured home that meets FHA requirements
- Mandatory financial counseling to make sure you understand the risks and process of taking out a reverse mortgage
If you meet the aforementioned criteria and are weighing the pros and cons of various income streams for retirement, it may be worth adding a reverse mortgage to your assortment of options.