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Smart and Safe Ways to Use a Reverse Mortgage

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Approaching retirement raises a number of questions about the next several decades of your life, many of which are financial-related. You need to consider what your expenses are likely to be post-retirement, including everyday needs, health care, travel costs, taxes and other financial obligations. Then you must look at your projected retirement income to identify any potential gaps and figure out how you’ll cover them.

If you’ve already retired, you may find yourself falling short of meeting your monthly expenses. Or maybe you’re able to cover your regular costs but are worried about not having enough cash or credit in the event of an emergency.

Whether you’re nearing retirement or are several years into it, navigating the financial terrain during this period of your life requires a multi-pronged strategy. For some people, that strategy includes taking out a reverse mortgage and drawing on the equity in their homes to fund their retirement needs.

A quick primer on reverse mortgages

Steve Irwin, executive vice president of the National Reverse Mortgage Lenders Association (NRMLA), describes reverse mortgages as “fundamentally a home equity product.” Unlike a traditional mortgage, a reverse mortgage does not require you to make monthly payments on the loan. Instead, you can choose to receive a lump-sum payment, a line of credit or monthly loan installments based on the amount of equity in your home (or a combination of the latter two) depending on your needs.

As long as that home remains your primary residence, you’re not obligated to pay on the principal or interest. However, you must stay current with insurance and property tax payments, and keep up with home maintenance. Reverse mortgages are non-recourse loans, which means that the amount you owe will never exceed the value of your house.

You don’t become eligible for a reverse mortgage until you’re 62, which is why they’re sometimes used as part of an overarching retirement strategy. How much you’ll be approved for depends on how much equity you have in your house, the current interest rate environment and your (or your spouse’s) age, according to Irwin. The older you are, the more funds you’ll be eligible to access. But if you’re co-applying with a spouse who is several years younger than you, their age could impact your borrowing power.

There are three types of reverse mortgages for which you may be eligible: a single-purpose, to cover a specific financial need such as home repairs; a proprietary mortgage, which is available on high-value homes through private lenders; and home equity conversion mortgages (HECMs), which are the most common of the three. HECM products are backed by the Federal Housing Administration (FHA) and therefore tend to carry lower interest rates than those backed by private lenders. Unlike single-purpose mortgages, HECM and proprietary reverse mortgage funds may be used for any purpose.

You’ll want to carefully explore all of the options and offer terms before deciding whether to take out a reverse mortgage and with whom.

Is a reverse mortgage right for you?

Reverse mortgages can be useful for managing your finances in retirement. You can use the cash or credit from a reverse mortgage to supplement your monthly income from Social Security and other sources, or to open a line of credit you can use for long-term medical care, health emergencies or other urgent needs. Irwin said that reverse mortgages can also be used to “right-size” into a home that better suits your lifestyle at this stage. “This is a really flexible product and it can be tailored to meet individual’s needs and wants,” he said.

However, it’s important to know exactly what you’re getting into with these products. Even the way you receive the loan proceeds — a lump sum, line of credit or monthly installments — can have a far-reaching impact on your financial security and legacy.

“Oftentimes people are surprised that if they take the lump-sum payment, for example, there might not be anything left for their heirs to inherit,” said Julie Schoen, deputy director of the National Center for Excellence on Elder Abuse at the University of Southern California.

Some borrowers opt for reverse mortgages to delay taking their Social Security payments so they can maximize the amount they receive from those benefits. But the Consumer Financial Protection Bureau (CFPB) reported in 2017 that the math doesn’t work out. Generally speaking, the costs associated with reverse mortgages are higher than the potential increase in Social Security benefits. Because reverse mortgages use up home equity, borrowers may find that they have less to borrow against when they need it later in life.

Although reverse mortgages can help people through financial challenges, Schoen said they should be “a last resort.” She recommended that borrowers explore other options, such as taking a home equity loan or selling their property and downsizing, before choosing a reverse mortgage. Irwin’s view is that reverse mortgages can be a healthy part of retirement planning but says people need to understand their needs and how they intend to use these products.

Know your long-term goals

Reverse mortgages are tied to your primary residence, so it’s important to consider how long you plan to stay in your home. If you’re early in your retirement and think you may want to downsize in a few years, know that you will have to repay the principal and interest once you move into a new house. For borrowers who want to age in place in their current locations, a reverse mortgage becomes a relevant option, along with a cash-out refinance or line of credit, said Jamie Hopkins, professor of retirement at The American College of Financial Services.

But for those with moving on their minds, reverse mortgages become a more complicated question. Before deciding to take out a reverse mortgage, Irwin said borrowers should ask whether their existing homes will accommodate their needs as they age.

Schoen said borrowers should also consider whether they plan to leave their homes to their children as part of their family legacies. If there’s still a debt on the house when the last borrower passes away, the loan must be settled. Oftentimes, this is settled through the person’s estate by selling the house to pay off the remaining balance, according to Hopkins. Families that want to maintain ownership can pay the loan directly or take out a mortgage on the property themselves. But that’s an additional financial burden borrowers may not want to leave for their loved ones.

Hopkins recommended talking with your children about their expectations before taking out a reverse mortgage. They may not want to inherit the house and may be willing to let it go when you pass away or move to a different location. But if inheriting a family home is deeply important to them and to your legacy plans, you’ll want to carefully consider the implications of a reverse mortgage.

It’s important to distinguish between your legacy value and the property, he added. A borrower whose priority is leaving as much money as possible to their heirs might choose to take a reverse mortgage so they can draw less on their 401(k) or other savings accounts.

But, “If the goal is to leave a specific house to the kids, they’re going to be hesitant on doing anything that feels like it’s putting a debt or a risk associated with the house,” Hopkins said. “Just practically speaking, if you attach a debt to the house, it’s more likely that the kids are just going to sell the house later on.”

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Work with relatives and trusted advisers

Before taking out a HECM, you are required to participate in mandatory counseling with a third-party adviser approved by the Department of Housing and Urban Development. Irwin recommended that potential borrowers take full advantage of that resource to make sure they’ll be comfortable with their decision.

“Are there questions some applicants may have that they want to make sure get covered? Are there some concerns or trepidation they need to talk through with the independent counselor? They should not hesitate to walk through all of that with their counselor,” he said.

To avoid predatory lending schemes, Schoen strongly advised against responding to reverse mortgage offers from lenders who cold-call you. “A lot of the scammers use the good old phone book and look for older sounding names and call them,” Schoen said. “If you’re at a time when you’re socially isolated and thinking, ‘Yeah, I could use a little more money in my bank account,’ you may be more susceptible to predatory tactics.”

Instead, she recommended asking trusted family members to help research reputable lenders and evaluate all angles of the reverse mortgage decision. As frightening as it can be to realize you’re strapped for cash, it’s important not to make emotional or impulsive decisions. “Sometimes people do find themselves short of cash and desperate, thinking this is a way out, but you can’t act on that,” she said.

When considering lenders, she noted that it’s worth considering their stake in the decision. “Why does that person want you to have a reverse mortgage? Is this somebody you know, you trust? Or is this somebody who called you randomly and you just responded because it sounded interesting?” she said. “This should be something that you’re in the driver’s seat, you’re pursuing.”

Schoen also suggested researching different lenders’ business ratings and reading reviews from past borrowers. Making informed decisions with the advice of third-party professionals and your loved ones will help you not only decide whether you should take out a reverse mortgage but also which lenders best serve your needs.

Ultimately, remember that it is your decision. Schoen said there are cases in which children will effectively coerce their parents into taking out a reverse mortgage, sometimes with disastrous consequences. There is some recourse in those instances, but oftentimes there’s not much that can be done if the borrower has already received the benefits of the loan. So it’s essential that you assert your decision and seek supportive advisers throughout the process.

A big impact loan

As with any borrowing decision, it’s imperative that you understand the risks and benefits associated with a reverse mortgage. While the loan can provide a measure of flexibility and security in retirement, there are significant trade-offs in how much equity you’ll have to borrow against later in life and what you’ll be able to leave to your children. The best thing you can do for yourself when considering a reverse mortgage is to take the time to understand your options and rights, and act according to what makes the most sense for your goals.


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