Did you read that correctly? Someone giving praise to a reverse mortgage? But the media says . . .

(Big sigh on my side. Oh the media!). Similar to annuities, permanent life insurance, financial advisors, (heck we might as well jump over to the US government, politicians, attorneys, the military, taxes and others), reverse mortgages have had a negative flavor in the mouths of most of the press and media.

I hope you can understand a few things.

First, that annuities, life insurance, financial advisors, attorneys, and the other categories listed above all do have very good purposes and help solve problems that wouldn’t be solved easily, otherwise (yes even the US government).

Second, the media has a pretty negative presence themselves. I am sure you noticed that it seems much more difficult for them to sell news if the news is not controversial (and bordering on slanderous/inaccurate). So, they are not the most trusted source either.

Now, if we switch gears and think that maybe the media is not always providing an unbiased breakdown of the uses of reverse mortgages (or other education on other pieces noted above), does that mean everyone needs a reverse mortgage?

No. Please do not go to either extreme with this conversation. Some people don’t need to think about reverse mortgages due to how strong they are financially (though they could still benefit), but many others should at least explore the program, in detail, to see if it could improve their financial well being and investment withdrawal rate risk. Make sense?

The point of this post is not to tell you if you need a reverse mortgage or not. The point of this post is to explain how reverse mortgages have been used, in real life, to improve the financial and personal lives of people in retirement. The post is also here to contrast that information with possible negatives someone could see in using the program. That way you can see if you want to explore the program more for yourself.

That cool? Everyone clear on the purpose?

This will be a little bit longer post because this topic is very diverse. I will keep things as simple as possible and not have this run too long. But, expect to do some reading.

First, what is a reverse mortgage?

Well, let’s jump into its basic info. A reverse mortgage, the FHA backed mortgage program, is actually called a HECM (Home Equity Conversion Mortgage) in the industry. All it is, is a home equity loan designed to create extra cashflow, liquidity, and income for older homeowners (you have to be at least 62 years old to use the program). If someone has a current mortgage, the HECM would replace that mortgage. If they don’t, the HECM would be put in place, similar to a cashout refinance or a home equity loan.

Also, quick note, there are proprietary reverse programs out there as well. Many are very good and could be better fits depending on the home and person. But, this post is largely focusing on the FHA HECM option, solely. Largely to keep the post shorter and simpler. But, looking at all options available is possibly beneficial.

How can it create extra cashflow? If you have a HECM for your mortgage, you do not have to make monthly payments on the mortgage (like you would with a traditional mortgage). So, if you currently have a standard mortgage that has a principle and interest payment of $1800 a month, that $1800 a month payment goes away and the only payment you have to make with this program is the final payment on the loan when you pay off the home loan with a home sale (or you refinance the loan, if desired). For that household, not having to make that $1800 a month payment (or whatever payment amount it actually is) could clearly improve their budget, massively (by a literal $1800 a month, in this example).

How can it create more liquidity? Depending on the amount of equity in the home, the homeowner may also be able to build an extra line of credit in the HECM, that they can use to offset unknown future expenses, or take advantage of unknown future opportunities. This line of credit cannot be frozen (like traditional home equity lines of credit can, such as in the 2008 financial crisis), so this equity is available no matter what life throws at the homeowner. And the line of credit does not need to be repaid until the home is sold (or the loan is refinanced), also. So, more liquidity but no negative affect to the cashflow like we discussed above.

How can a HECM create more income? Again, depending on the amount of equity in the home, the homeowner can choose to create the extra line of credit within the HECM (allowing them to draw extra money when needed). They can also, potentially, “annuitize” some of the equity. Just like an income annuity, this would create fixed monthly income for life (called Tenure) or for a certain number of desired years. If someone, for example, were to both wipe out $1800 a month of principle and interest payments from their budget, and choose a fixed monthly disbursement payment of $500 a month from the HECM, that someone would now have $2300 more monthly income available for other needs (such as living a fuller life – which is the goal of retirement and hopefully your life in general).

There are a number of other uses, historically, with the reverse mortgage. I will go into those, but really fast, lets start with some of the “cons” of the reverse mortgage. I did quotation marks around “con” because these pieces are not exactly cons, but still need to be understood and discussed.

“Con” number 1: This is still a mortgage. You are not getting away with having your mortgage debt forgiven or something magical like that. This program allows you to access your wealth inside your home without it being a detriment to your monthly cashflow (and it can obviously improve your monthly cashflow, dramatically). But you still have to pay your accrued balance off when you no longer live in the home. Also, you still have interest costs that need to be paid with this mortgage, just like a normal mortgage. The change is that with a traditional mortgage, you pay the interest and principle monthly (every month, no matter what, or you could lose the home). With a HECM, you pay the accrued interest (over however long you have the mortgage) and the principle owed by selling the property down the road (or you do a refinance). So, you are not getting away with never having interest costs and principle payback.

Side note here: You can still make payments on this mortgage while you have it. If you end up having more cashflow than you need during the year, feel free to make payments on the HECM and pay the balance down. This program does not stop you from making payments, it makes it so making payments is optional.

Side note number 2: Just a quick reminder (because I have people ask about this occasionally), the HECM borrower still owns the home fully. This is just a lien on the property like any other mortgage. There is no ownership change (and cannot have a change because the loan is in the property owner’s name – just like every other mortgage).

“Con” number 2: If you end up having this mortgage for a very long time (25 or 30 years), and you choose to make no payments while you have the mortgage (which is normal), your interest accrual COULD – not Guaranteed, eventually, use up most or all of your equity. Since your interest keeps building (as no one is paying it monthly), it mathematically could grow to the same value of your home or more. This seems like a big risk, but if you saved yourself $1800 a month in mortgage payments for 30 years (as an example – which would be $648,000 in no payments in that time), you likely are in a much better position because of it. So, again, you would just figure out if having a fuller life due to not being strapped for cash monthly is more important, or what is the total best use of your equity. Most people obviously do not stay with a mortgage or in a home for 30 years, so for most people, this conversation of using all of your equity will be irrelevant.

Side note, again: A HECM is what is called a Non-Recourse loan. This means that even if the balance that was owed at the end was higher than the home’s value, FHA could not come after the estate or the homeowner for anything more than the home sale proceeds. So, if someone did keep this program for 30 years and the balance was over the home’s value, it is of no worry. The home is simple sold or provided to the mortgage company, and anything that is owed above the value would have to be absorbed by the Federal Housing Administration (FHA) and their mortgage insurance fund. The homeowner or their estate is free from any obligation beyond providing the sale proceeds available.

Side note, again, number 2: Just a reminder, like any other mortgage, if there is still equity in the home when the homeowner sells the property (or refinances), that equity stays with the homeowner (or their estate). Only the amount owed on the mortgage (principle balance and interest) goes to FHA so the loan is paid in full.

“Con” number 3: Just like every refinance or purchase (yes you can buy a home with a reverse mortgage, so keep that as a great tool to buy a home and have no mortgage payments), there are fees that need to be paid to acquire the mortgage. The con aspect of the HECM program is the fees will be higher than normal mortgages because the mortgage insurance (that allows the mortgage to be a non-recourse loan) does not get paid monthly like with a traditional mortgage where you make monthly payments. So, the cost of the mortgage insurance is lumped into the costs of putting the mortgage in place. These fees do need to be accounted for in making sure the HECM program will ultimately improve the homeowner’s financial position. Clearly, if someone moves forward with a HECM, it is because the benefits clearly out way the costs (which is going to be pretty evident).

“Con” number 4: Again, these are not really cons, but are important requirements of loan qualification. I’ll list them out.

1. The HECM has to be on your primary residence. So cannot be on a vacation home or investment property (or farm/ranch, etc.).
2. You have to be age 62 or older to qualify. The focus of the program is for helping retirees/older homeowners.
3. You have to still pay your property taxes and homeowners insurance, on time. And you have to maintain the quality of the home. This should be a no brainer, but I felt it still should be noted. If you did not follow through on these pieces, you could be foreclosed on (if it was bad enough). But that is the exact same as every other mortgage (and frankly, even if you don’t have a mortgage, if you don’t pay your property taxes you can lose your home).
4. Not all of the equity that is available with the HECM is available the first year you have the mortgage. This prevents people from overspending their equity early on and losing out on it being available later, when they may need to have some saved.
5. Interest rates can be fixed or adjustable. But, very few people choose to go with a fixed interest rate option because they lose out on the line of credit with that program. The line of credit is a very important tool to provide liquidity and extra safety. So, most will go with the adjustable rate program options. Again, not a “con” because you gain more options, but good to know up front.
6. In order to qualify for a HECM, you do need to have a substantial amount of equity in the home already (percentage wise compared to the home value). Depending on the homeowner’s age, interest rates, and other factors, it would be smart to expect that you need to have 50% to 70% equity in the home. This protects FHA from a homeowner being too likely to use all their equity quickly and then having the interest build above the homes value some day (and they lose money by absorbing the overage).
7. And there are more qualifying requirements, of course.

Planning Options/Directions

Alright. So, now we are past some of the basics. Let’s move to how people are using this program to improve their older years of life? Let’s go through some of the financial planning pieces that coordinate Social Security Income, investment income, pensions, annuities, and home equity.

What I will do to keep this simple is outline some of the major focal points advisors and retirees have in their financial and retirement planning. This should help you visualize the strategies.

1. Reducing Household Monthly Expenses – not to sound repetitive, but just a reminder that one of the major aspects of the HECM program is that the homeowner/retiree no longer has to make mortgage payments, as long as they live in the home (if they refinance a current mortgage to a HECM). They can make payments, if desired, whenever they feel like it. Or they could never make another payment again and use that money for other purposes. Budgeting wise, this can provide much better standards of living. Separately, if they didn’t have a mortgage originally, they could use a HECM for income or liquidity and not worry about paying equity back monthly that would reduce their monthly income (which any home equity loan or other mortgage would require).
2. Reducing Sequence-Of-Return Risk with investment portfolio withdrawals – If the homeowner opts to go a direction that includes a line of credit inside the HECM, they can choose to pull income out of the credit line during years of market decline. Thus, making sure to not sell/liquidate investment holdings during times where they would lock-in major losses. This can obviously improve the likelihood that their investment portfolio would not be depleted during their lifetime. A major concern for most in retirement.
3. Reduce Spending Shocks – Another major risk of potential portfolio and asset depletion during retirement is large and unexpected expenses. Events like major health scares, long-term care, large home repairs and others can cause unexpected withdrawals from investments and savings and severely harm the portfolio’s long-term health. Using the same line of credit option in the HECM can allow the homeowner to cover those unplanned expenses with the HECM funds, instead of depleting investments, especially during times of market declines.
4. A Bridge to Full Social Security Retirement Age – Many households would benefit most if they could delay taking Social Security for the primary bread winner until 70 years of age. Using the fixed monthly disbursement option or the line of credit to fund income needs until that time can provide a large benefit to their long-term financial plan. This can also be used the same for postponing the use of an Income Annuity until later ages that provide larger payouts.
5. Tax Bracket Management – for the most part, home equity should be a tax-free asset for older homeowners. Combining the line of credit option with the taxable, tax deferred, and Roth investment buckets can allow the homeowner to manage the tax brackets that they are in, more easily. Utilizing more tax free funds (equity) to provide their income would improve quality of life without increase taxable income.
6. Reducing Cash Drag – Traditional wisdom would include focusing on having a decent amount of liquid and low volatility money set aside during someone’s retirement years to cover 1 to 3 years of expenses. This money is traditionally housed in cash or cash equivalents to make sure it is liquid and unlikely to drop in value, when needed. The negative with holding this much in cash, or cash equivalents, is it reduces the performance of your overall investment portfolio. Using the line of credit option with the HECM as your safety reserves would build you the liquid funds you need without requiring large cash reserves to be set aside within your portfolio. Allowing more money to stay invested, producing gains, dividends, and interest.
7. Extending the ability to stay in the home – for older homeowners, often a large desire is to stay in the home as long as possible, and push off the need of going to an assisted living or nursing home facility. With using the equity in one’s home (via up-front withdrawal, the line of credit option, monthly disbursements or all of the above) it is easier to fund in-home care costs and home improvements so the homeowner can comfortably stay in the home with age. Again, payments are not required on the funds withdrawn until the home is sold or the homeowner no longer resides in the home.

Wrapping this up.

There was a lot of information in this post. Hopefully it helped you think about the major components of a reverse mortgage in new ways. Again, this post is not attempting to provide advice. This post is designed to provide ideas on how reverse mortgages (HECMs) are used and why they are used. Along with what to think about as possible positives and negatives to using one. You get to choose if you feel that you or a family member should get more information from here.

And, just because it looks cool (though it has nothing to do with this post), here is the winner of “Close Up Photographer of the Year” Picture –