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Understanding Reverse Mortgages for Retirement Planning

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Once, reverse mortgages were considered to be the financial stepchild of retirement income sources. But respected authorities like Wade Pfau have shed new light on its potential uses in a retirement strategy. Now, growing shares of financial professionals, retirees, and other Americans see their benefits for certain situations.

If you have any pre-conceived notions about reverse mortgages, you might have formed them while watching those TV commercials with Tom Selleck, Robert Wagner, Henry Winkler, or one of many other well-known personalities.

You might ask, "What roles might a reverse mortgage play in my retirement income plan?" That is a good question. Let’s take a look at some potential uses for a reverse mortgage, including what it may involve.

Reverse Mortgages 101

A reverse mortgage is a form of home equity loan for homeowners age 62 or older. They receive monthly payments from their lender based on a percentage of their accumulated home equity.

This essentially turns an illiquid asset, their home, into a liquid asset, retirement income. They do not have to make monthly payments on the reverse mortgage and the loan accrues interest and is repaid at one of two occurrences:

1) when the borrower sells the home and moves, or
2) when the borrower passes away.

Essentially a reverse mortgage allows a borrower to leverage the value of their home, built up over time, to create a potentially lifelong income stream. The reverse mortgage can be used to pay off an existing mortgage, freeing up income that would have been used to make those monthly payments.

A Changing Landscape for Reverse Mortgages?

According to well-known retirement planning expert Wade Pfau, Ph.D., CFA, "Though reverse mortgages have long held a bad reputation, research and public policy in recent years are shedding new light on their potential uses in retirement."

Writing on RetirementResearcher.com he adds, "Reverse mortgages have transitioned from a last resort to a retirement income tool that can be incorporated as part of an overall efficient retirement income plan."

In addition to being at least age 62, reverse mortgage borrowers must live in the eligible home. They also must not have any other debt on the home. The home must be owned free and clear.

As part of qualifying for the mortgage, borrowers attend a mandatory counseling session on the loan. They must also have an assessment of their resources to ensure they can meet normal homeowner obligations.

New and Improved?

The first federally-insured reverse mortgage was introduced in 1989. Also known as a Home Equity Conversion Mortgage or HECM (commonly pronounced 'heck-um'), these reverse mortgages are regulated and insured through the Department of Housing and Urban Development (HUD) and the Federal Housing Authority (FHA). The vast majority of reverse mortgages in the U.S. are HECM reverse mortgages.

Dr. Pfau points out that since 2013, "the federal government has been refining regulations for its HECM program in order to improve the sustainability of the underlying mortgage insurance fund, to better protect eligible non-borrowing spouses, and to ensure borrowers have sufficient financial resources to meet their homeowner obligations."

The financial crisis that began in 2008 also affected reverse mortgage holders. Such was noted in a brief from the Center for Retirement Research at Boston College issued shortly after the 2013 refinements to the HECM program. In the brief, the center observed that the financial crisis hurt both the government’s insurance fund and the borrowers.

"Declining home prices led to losses when homes were sold. More borrowers defaulted," the brief synopsizes. "In response, the government has redesigned the program by creating a single loan option with a lower limit and fees; limiting initial withdrawals; and requiring financial assessments of borrowers. These changes should help reduce pressure on the insurance fund and make defaults less likely."

Highest and Best Use

Reverse mortgages can be used to form the backbone of an efficient retirement income plan. This tool can help reduce the stress on retirement accounts and investment portfolio assets to generate income for people to enjoy a lifestyle that's meaningful to them.

Because we all face the possibility of living longer, our retirement assets are potentially exposed to more market downturns. Sequence risk, or the hazard of sustaining portfolio losses in early-retirement years, might also be a potential threat. Having the option of generating income from your home, allowing your assets to stay in the market and recover from any dips, is another potential benefit of income from a reverse mortgage.

Financial planning research has shown that coordinated use of a reverse mortgage starting earlier in retirement outperforms waiting to open a reverse mortgage as a last resort option once all else has failed.

Pay Off Your Existing Mortgage

While creating a monthly income stream and easing pressure on your market-linked retirement assets are two primary reasons people consider reverse mortgages, another popular motivator is wanting to pay off a mortgage and end monthly mortgage payments.

Bankrate.com provides this example of using a reverse mortgage to pay off an existing mortgage: A couple with the youngest spouse age 62 has a house worth $200,000 and a $62,000 mortgage.

"Based on their ages and the home’s value, they can get a reverse mortgage for up to about $90,800. This is known as the principal limit or maximum loan amount. Closing costs, including FHA initial mortgage insurance, reduce that available amount to about $80,570."

Bankrate.com continues, "Under FHA rules, the amount they borrow is limited in the first year. If they borrow the $62,000 to pay off the mortgage, they can take out another $9,080 in cash during the first year. A year later, the remainder is available to them."

Does It Make Sense for You?

A reverse mortgage is one of many potential tools in the wheelhouse that you may have at your disposal for planning your ideal retirement. Working with a knowledgeable financial professional, you can evaluate your situation and determine if a reverse mortgage might make sense for you.

If you are ready to explore your retirement options, financial professionals at SafeMoney.com can help you. Use our "Find a Financial Professional" section to connect with someone directly. Should you need a personal referral, call us at 877.476.9723.

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