If you are in or nearing retirement, one question that is likely to be on the top of your mind is “Will my retirement funds last throughout retirement?”
That’s a tricky question to answer because there are so many things that cannot be predicted in retirement. For instance, how long will you live? Longer life means your money must live longer, too. What will the rate of inflation be? Higher inflation means you’ll need to keep up with higher costs. What financial shocks — like medical expenses — will you face in retirement? Spending surprises or reductions in cash flow could drain your retirement assets faster.
Retirement in Turbulent Economic Times
Household budgets across the country are being squeezed by rising prices of everything from food to gas. Rapid inflation can be especially hard on seniors, many of whom live on a fixed income. Retirees generally won’t benefit from wage increases intended to keep pace with inflation. And compared to the general population, retirees usually have more long-term health care needs. Health-care inflation can have a big impact on a retiree’s budget.
The Fed has been stepping up its fight on inflation by aggressively raising interest rates, a tactic meant to slow demand and temp down wage and price growth. Higher interest rates increase the cost of borrowing, for both families and businesses. This, in turn, allows demand to catch up, as higher borrowing costs tend to reduce disposable income and bog down consumer spending. However, this economy-cooling effort could produce the unintended consequence of tipping the economy into recession.
To make matters worse, unrest in the equity markets is chipping away at nest eggs — the S&P 500 recently entered bear-market territory (defined as securities falling by 20 percent or more from recent highs). Retirement is usually a period of asset decumulation — when retirees start converting their nest eggs to income to maintain a comfortable retirement. When the equity markets retreat, retirees usually have less time to wait for the markets to rebound.
For these reasons and more, many older Americans are worried they may have to sacrifice the quality retirements they worked hard for.
A Bright Spot: Housing Wealth
Homeowners aged 62 and older saw their combined housing wealth soar to a record $10 trillion+ in 2021, according to the National Reverse Mortgage Lenders Association (NRMLA). For many older adult homeowners, housing wealth is their largest single financial asset. Conventional wisdom has been to view the home (and the equity in it) as legacy — something that’s not to be touched until all other viable options have been exhausted.
However, now more than ever advisors and older-adult homeowners are viewing home equity, and consequently reverse mortgage loans, in a financial planning sense — something to establish access to early in retirement (even before it’s needed) as a means to help preserve financial flexibility and liquidity to manage expenses over a long retirement period.
What is a Reverse Mortgage and How Does it Work?
A reverse mortgage is a home-secured loan that allows older-adult homeowners to convert a percentage of their home equity into cash, fixed monthly advances, or a growing line of credit — and defer repayment until a later date. A Home Equity Conversion Mortgage (or HECM) loan is the most common type of reverse mortgage and the only one insured by the Federal Housing Administration (FHA). This article refers just to the HECM reverse mortgage product. To be eligible for a HECM reverse mortgage, you must be 62 or older and own your own home.
The reverse mortgage loan’s repayment flexibility is what really sets it apart from other types of cash-out or refinance mortgages. The borrower can pay as much or as little toward the loan balance each month as they desire, or they can defer repayment until the home is no longer their primary residence. Like any mortgage, however, the borrower must pay the property-related taxes, insurance, and upkeep expenses.
The reverse mortgage balance typically becomes due and payable when the last surviving borrower permanently moves out of the home (e.g., moves into a nursing home) or passes away, and is typically satisfied through the sale of the home. This brings us to another top feature: it’s a non-recourse loan. Non-recourse means the home stands for the debt — not the borrower nor their heirs. So even if the loan balance grows over the years to be higher than the value of the home, when the loan matures and the home is sold, neither the borrower (nor their heirs) will be personally liable for any deficiency balance*.
Why Now May Be the Right Time for A Reverse Mortgage
With all the economic uncertainty and today’s rising interest rate environment, you may be wondering why now could be an ideal time to consider a reverse mortgage. Let’s explore, shall we?
1. You Want to Refinance Your Mortgage (or Other Debt) and Free Up Cash Flow
If you are still carrying a mortgage balance in retirement, you are not alone. According to a recent survey conducted by American Financing, 44 percent of 60- to 70-year-old homeowners bring their mortgage into retirement. If you are looking to lower your monthly mortgage payment by way of refinancing into a new traditional mortgage, you likely will find that you already have a lower interest rate than what’s available on the market right now, especially if you’ve refinanced your mortgage (or financed the purchase of a new home) in the past few years when interest rates were at or near historic lows. In April 2022, the average 30-year traditional fixed mortgage interest rates stretched above 5 percent for the first time in a decade, and it more recently breached the 6 percent threshold.
The good news is that with a reverse mortgage, you can use some or all of the reverse mortgage proceeds to pay off your existing mortgage. Essentially, you’d be refinancing your forward mortgage into a reverse mortgage. While the reverse mortgage interest rates are currently competitive to (or even a bit lower than) conventional mortgage rates, it’s the repayment flexibility — freeing yourself from the burden of fixed monthly mortgage payments — that could make right now the right time for you to refinance into a reverse mortgage. So rather than month after month, year after year, being required to direct a good chunk of your retirement cash flow toward paying down your mortgage — with your money getting stored in your home, a very illiquid asset — you could refinance the balance into a reverse mortgage and have more control to manage your cash flow and expenses over a lengthy retirement period.
You can also use the loan proceeds to refinance other debts you have. If you have high-interest credit cards, personal loans, or other debt with required monthly principal and interest payments that are choking your monthly cash flow, you may find it advantageous to refinance that debt using reverse mortgage loan proceeds.
2. Housing Boom May Go Bust
While it’s true that home values tend to rise over time, there is no guarantee that in the short to medium term your home will hold its current value. In fact, as history has shown, given the right market conditions, housing prices could fall sharply. No one knows for sure where the housing market is headed, but with recent hikes in mortgage interest rates that have made homes less affordable for buyers using financing, one could argue that the stage is set for home prices to pull back, at least modestly, in the near future.
The amount of home equity you are eligible to access with a reverse mortgage is based on the age of the youngest borrower (or non-borrowing spouse), the interest rate on the loan, and the value of your home up to the FHA principal limit.
You can get an idea of how much equity you can access by using our reverse mortgage calculator.
Other than your age, the most important factor in determining how much money you will be able to borrow with a reverse mortgage is the value of your home. The appraisal determines the value of your home. Even in today’s rising interest environment (the higher the expected interest rate, the smaller the percentage of home equity you can access via a reverse mortgage), you may still be able to access more equity from your home than you could have a few years ago (when interest rates were lower) because home values in most markets have soared.
And since a reverse mortgage is a non-recourse loan, you don’t have to worry about being upside down on the loan — the sale of the home will always satisfy the loan when the loan matures, even if home prices crater or the borrower defers repayment of the loan balance for a very long time.
That’s all the more reason why now may be a good time to lock in today’s value of your home.
3. You Want to Maximize the Potential of the Line of Credit Growth
The most popular way to access reverse mortgage funds is via a line of credit. The line of credit — which can be borrowed from, paid back, and borrowed again — cannot be capped, reduced, frozen, or eliminated, so long as the borrower complies with the loan terms.
And it can be to your advantage to establish the reverse mortgage line of credit sooner rather than later because the unused portion of the funds grows over time at the same compounding rate as the loan balance. If you are using the reverse mortgage line of credit in a financial planning sense — establishing the variable rate line of credit before it’s needed, not drawing from it (or strategically drawing from it), and letting the unused balance grow — you would benefit from a rising interest rate environment, since higher interest rates increase your borrowing capacity at a faster rate.
4. You Are Looking to Establish a More Efficient Retirement Cash Flow Strategy and Better Manage Retirement Risks**
A good retirement-income strategy combines the best retirement-income tools for meeting one’s goals while protecting against risk, like health care costs and downturns in the equity markets. The strategic use of your home equity via a reverse mortgage could help you to establish a more efficient retirement-income strategy and mitigate retirement risks.**
For example, you could use the loan:
As a way to coordinate between spending from your investments and your reverse mortgage — potentially better protecting your investment portfolio from market volatility. For instance, a borrower could draw needed cash flow from the line of credit during market downturns instead of selling investments at depressed prices. This may give the portfolio time to recover and help the borrower to extend the life of his or her traditional investments**.
To pay for life insurance
To pay for long-term care insurance (LTCI)
To pay for aging-in-place home renovations
To pay for health insurance while waiting for Medicare (62-65)
To close gaps in your retirement cash flow
5. You Want to Buy a New Home
There are many older-adult homeowners who would like to downsize, upsize, or right-size into their dream home — or simply a new home that better meets their lifestyle in retirement. But the current challenging housing and borrowing environments are causing some of those prospective homebuyers to put the brakes on their retirement housing lifestyle dreams. Some of the reasons for their hesitancy to move to include:
Feeling that they are priced out of the current market
Not wanting to take on a new mortgage payment in retirement
Not wanting to give up some or all of the proceeds from the sale of their current home and/or to have to drain their retirement savings to pay in all cash
Feeling they wouldn’t qualify for a mortgage because of past credit blemishes or reduced income in retirement.
Historically, there have only been two ways to buy a new home: in all cash or with a mortgage that requires monthly principal and interest payments.
Now there’s a third way: Buy the new home using a reverse mortgage — through what’s known as the Home Equity Conversion Mortgage for Purchase (H4P) loan program. Many older-adult homebuyers don’t know about this loan option, and that’s a shame because it’s an option designed specifically for them and their needs at this phase of their lives.
As with most traditional mortgage transactions, the borrower supplies a down payment to supplement the H4P financing. You can buy a new home by putting as little as 45 to 70 percent of the purchase price down†, and you are not required to make monthly principal and interest mortgage payments (must still pay the property-related taxes, like taxes and insurance). So, it feels a lot like an all-cash purchase, but you get to keep more of your retirement assets to use as you wish.
The H4P loan is generally easier for a 62+ homebuyer to qualify for compared to a conventional mortgage. There is no minimum credit score requirement; however, since the property charges (e.g., taxes and insurance) must be paid over the life of the loan, the lender will conduct a financial assessment of your credit history, property charge history, and monthly residual income when deciding whether to approve your loan.
Not having to take on required monthly principal and interest mortgage payments in a rising interest rate environment can have a big impact on one’s retirement cash flow. And the increased buying power the H4P loan offers can help you to purchase and better afford the home you really want — and that can make all the difference for you and your retirement.
Is a Reverse Mortgage Right for You?
At Fairway, we understand that each of our customers has unique needs, and sometimes a reverse mortgage is the best fit — and sometimes it is not. If you’re interested in learning more about reverse mortgages and whether one might be a good fit for your situation (or a loved one’s situation), Fairway can help.
Connect with us today to learn more.
*There are some circumstances that will cause the loan to mature and the balance to become due and payable. The Borrower is still responsible for paying property taxes and insurance and maintaining the home. Credit is subject to age, property, and some limited debt qualifications. Program rates, fees, terms, and conditions are not available in all states and are subject to change.
**This advertisement does not constitute tax or financial advice. Please consult a tax or financial advisor regarding your specific situation.
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