People approach retirement with a wide range of circumstances. One of these circumstances is where the potential retiree has a large part of their net worth sitting in their primary home. If this is you, then fret not. There are options.
One of your options is a reverse mortgage – also called a home equity conversion mortgage (HECM). Reverse mortgages sometimes get a bad rap, and it is definitely justified when they get pushed by sales people as a retirement cure-all. There are cases, however, where a reverse mortgage might be useful.
Ensure that all of the following apply to you; if at least one of these does not, then you likely have better alternatives than a reverse mortgage:
- You own a significant amount of equity in your house.
- You are not planning to pass the house down to any heirs.
- You wish to age in place (i.e., the house is your “forever home”).
- There is a possibility that your non-home finances will fall short at some point during retirement.
If all of thee above apply to you, then a reverse mortgage should be on the table as an option. Assuming you’re at least age 62 (the earliest age for an FHA-insured HECM).
Reverse mortgages are still an option for ages 55 to 61, but they are not FHA-insured. If you are in this age group and looking to tap into your home’s equity, then take a look at what changes when the reverse mortgage is not FHA-insured. These proprietary reverse mortgages are outside the scope of this post.
A reverse mortgage is a line of credit, therefore you only “pay interest” on the amounts that have been withdrawn. “Pay interest” is in quotes here because the actual payment gets added to the withdrawn balance, rather than coming from your pocket.
The line of credit is capped by a certain percentage of the principal (i.e., your equity in the house). After opening the reverse mortgage, this cap increases annually by a pre-determined amount. This increase happens even if the value of the home decreases. If you instead try opening a reverse mortgage in later years, it is unlikely to provide for a higher percentage of principal.
You need to understand your financial situation here to determine when to take out a reverse mortgage. Due to the line of credit increase, you’re incentivized to take it out as early as possible. However, things change in retirement. Will the four factors in “Before Going Further…” remain constant throughout?
Withdrawals are tax-free, since a reverse mortgage is a loan.
There are some constraints that still need to be met when getting a reverse mortgage:
- Maintenance is still expected to be performed by you, the homeowner.
- You still need to pay the homeowners insurance and property taxes.
- The house needs to remain your primary residence.
The loan only comes due if you sell the home, the home is no longer your primary residence, or you die. There are no further obligations, as the home itself will satisfy the loan. Even if the home value is below the line of credit amount, the mortgage insurance covers the shortfall.
If your heirs wish to obtain the house after your death, they do have the option to pay off the balance of the loan. If they do not, either the heirs or the lender sell the house to repay the balance, and the remainder goes to your estate.
References
Reverse Mortgage Guide: Types, Costs, and Requirements, by Amy Fontinelle, Investopedia
HECM vs HELOC: Which is Better?, by Lindsay VanSomerenm, LendEDU
Reverse Mortgage vs Home Equity Loan vs HELOC: What’s the Difference?, by Jean Folger, Investopedia
Home Equity Conversion Mortgages for Seniors, U.S. Department of Housing and Urban Development
With a reverse mortgage loan, can my heirs keep or sell my home after I die?, CFPB
