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As the stock market turns volatile but the housing market remains hot, reverse mortgages have become a more attractive tool for older Americans who need cash for retirement but want to stay in their homes.
Mortgage volume rose 26% in March, according to data from the US Department of Housing and Urban Development reported by service provider Reverse Market Insight. It fell 3.8% in April but remained well above 6,000 loans for the month – above the average for recent years.
The economics of reverse mortgages aren’t as good as they used to be. In 2017, rule changes made by the U.S. Department of Housing and Urban Development, which administers the HECM program, increased the mortgage insurance premium on loans to 2%, from 0.5%, in an effort to reduce potential losses to taxpayers. This increased the initial costs of reverse mortgages by $1,500 per $100,000 face value of the mortgage.
However, conditions in the reverse mortgage market are favourable.
“This is still a great opportunity to consider a reverse mortgage,” said Wade Pfau, PhD, principal and advisor at Tysons, Va.-based McLean Asset Management. “There has been a sharp increase in house prices and interest rates are still historically low.”
Reverse mortgages have developed a strong following in the financial planning profession, with advisers like Pfau recommending them as a potentially useful option in managing pension distribution.
Home equity makes up about 66% of the average American retiree’s wealth. So it makes sense to use it as a potential source of funds if you’re short on cash, even if the costs are higher now.
“Research in the financial planning profession consistently shows that reverse mortgages can improve retirement planning outcomes,” said Pfau, who has written a book on the products. “It helps to have another source of funds outside of an investment portfolio that can provide a safety net for people.”
The idea is that even if you don’t need cash immediately, setting up a line of credit through a reverse mortgage on the right terms can give you access to significant funds later. . The line of credit will continue to grow at the rate of the reverse mortgage interest rate, regardless of what happens to the value of the home. In other words, a reverse mortgage hedges the risk of falling house prices.
If you have an investment portfolio, then you can decide to sell investments or draw down the line of credit when you need cash. It may sound a bit like market timing, but Pfau suggests a simple rule to guide the decision.
“If your investments are worth more than when you retired, sell from the portfolio,” he said. “If not, pull down the reverse mortgage line of credit.”
Not all advisors are sold on reverse mortgages. Certified Financial Planner Howard Hook, Senior Wealth Advisor at EKS Associates in Princeton, New Jersey, only spoke to two clients about the reverse mortgage option, with one eventually getting a loan .
Main advantages and disadvantages of reverse mortgages
- With interest rates still relatively low and real estate prices very high, borrowers can leverage almost 60% of the equity in their property on average on very good terms in the form of lump sum payments, monthly installments or line of credit bearing interest only on withdrawals. .
- Reverse mortgages are non-recourse loans. As long as you pay the property taxes and maintenance expenses, you can stay in the house as long as you want and the terms won’t change no matter what the housing market or interest rate changes in effect. . The loan is due when you die or leave the house.
- A reverse mortgage line of credit provides flexibility in managing the distribution of retirement benefits. It allows a borrower to make tax-free withdrawals from the line of credit rather than selling investments (and paying taxes) after a market downturn.
- It’s easier to qualify for a reverse mortgage, but they’re more expensive than other mortgages and home equity lines of credit. If for health reasons or for any other reason you do not stay in the house for long, the costs will seem even higher.
- If you use the proceeds of a reverse mortgage for questionable expenses or risky investments, you risk financial ruin. If this is a last resort for obtaining funds, you are probably living an unsustainable lifestyle. “The best option is to downsize your home and reduce your expenses,” said Hook of EKS Associates.
- Homeowners are still responsible for paying property taxes, insurance and home maintenance costs. The lender could seize the property if you don’t.
“I know a lot of reputable people who like reverse mortgages, but I’m still hesitant to advise clients to consider them,” Hook said, though he acknowledges the current economic environment is good for the product. “One must be careful in using debt to finance living expenses or to meet a drop in [stock] market.
“It’s easy money and it can foster bad habits.”
Hook thinks reverse mortgages may be appropriate when borrowers need to pay off health care costs or more expensive mortgages or personal debt and don’t want to sell their investments. But the overall cost and risk of the reverse mortgage is still high.
“Setting it up like a line of credit cuts the cost, but it’s still expensive,” Hook said. If you end up staying in the house for a short time, the costs will seem significantly higher.
“All of a sudden you may realize you can’t climb stairs or you develop dementia,” he said. “Sometimes the decision to stay in a house is not up to you.”