Reverse mortgages, in which borrowers can convert some of their home equity into cash, are becoming increasingly popular – particularly among older Americans who would like an additional stream of income in retirement. Like many financial advisers, I’m not a fan of reverse mortgages. Generally, I’ve thought of these loans as a last resort, and not the best option for most clients. But an article in the Wall Street Journal last week got me thinking about situations in which a loan like this could make sense.
First, let’s look at who can qualify for a reverse mortgage. Borrowers who participate in the FHA’s Home Equity Conversion Mortgage, or HECM, program must be at least 62 years old, own their home outright or owe a small amount, occupy the residence, be current on any federal debt, and have the financial resources to keep up with their property taxes and homeowner association fees.
Proponents of these reverse mortgages tout many benefits, including providing a source of income in which the proceeds can be tax free. In many cases (though each situation is different), the income from reverse mortgages won’t impact Social Security or Medicare payments. HECMs also have a non-recourse clause, which prevents the borrower (or the borrower’s estate) from owing more than the value of the home when the loan becomes due and the home sells.
The pitfalls of reverse mortgages are also many. Typically, these loans carry higher origination fees and closing costs than conventional loans. In addition, borrowers who fall behind on their property taxes or HOA fees risk foreclosure, and the loan becomes due if the borrower or co-borrower fails to live in the home for a continuous year (for example, if the person were hospitalized or in a nursing home).
Despite the arguments in favor of reverse mortgages, I still find them too risky for my taste. To me, it would be like advising a client to take the equity from her home (an asset that’s safe) and invest it in the market. For clients seeking cash flow, a reverse mortgage would probably not be my first recommendation. That said, however, a home equity line of credit through the HECM program could be a great safeguard for those who prefer to borrow instead of withdrawing from their investments in a bear market, as the Wall Street Journal article mentions. The upside in this situation is that the line of credit can’t be cancelled the way other lines of credit could during a market downturn – exactly when someone might need the money most.
If you’re considering a reverse mortgage, my best advice is to do your homework. How would a reverse mortgage serve your long-term retirement goals? What other options are available? What are the implications for your finances, tax situation or estate plan? Educate yourself at some of these websites:
And, as always, please feel free to contact us at AMDG Financial if we can be of assistance.