You finally made it into retirement and have the gray hair to prove it. You have dreams of walking hand in hand with a spouse or running free along a sandy beach. The kids are grown and living their own lives; now it’s time for you to live yours.
But the living isn’t always easy for new retirees. Money may be tight due to the stormy economy, the money you do have must stretch further longer due to longer life expectancies, and health care costs are rising. It is difficult to calculate how long your portfolio will last given the variability of market returns. William Sharpe, Stanford professor and winner of the 1990 Nobel Prize in Economic Sciences, noted that retirement-income planning was one of the most complex problems he has ever analyzed.
Traditionally, once you retire, your sources of retirement income will be Social Security benefits, pensions and annuities, and withdrawals from qualified retirement and non-qualified savings accounts. But what about an asset that may well be your largest: the equity you have in your home? You may not have thought about your house as a component of retirement income, but experts in retirement-income planning are now focusing on housing wealth as a way to achieve more favorable outcomes in retirement.
One option for tapping wealth in your home is a reverse mortgage, which is a loan that uses the borrower’s primary residence as collateral. For those at least sixty-two years old with home equity or housing wealth, it is an opportunity to access equity as a source of money for any emergencies or opportunities that may arise. Unlike a typical mortgage, there is no monthly payment. The mortgage must be repaid only when the borrower moves, sells the house or passes away.
All reverse mortgages are typically federally insured Home Equity Conversion Mortgage (HECM) loans. Under the HECM provisions, loans can be made on assessed home values up to the Federal Housing Administration current limit of $625,500.
The caveat is the borrower must be able to pay taxes, insurance, and maintenance. If the borrower doesn’t keep up with these payments, there is a possibility of losing the house. Homeowners can take a HECM loan in the form of monthly payments, a lump sum, or a line of credit.
The amount a borrower is eligible for depends on three factors:
- Value of the home: The more valuable the home, the greater the available amount up to a maximum ceiling.
- Age of borrower: The older the borrower, the more money that can be accessed because there is less time for interest to accrue.
- Interest rates: The level of prevailing interest rates and the cost of mortgage insurance determines the available principal that can be lent to the borrower. The interest rate, which may be fixed or adjustable, also varies depending on what lender is selected. Choosing a loan with a lower interest rate can help save money.
As with all financial decisions, fees are an important consideration and can affect the amount of available equity in the home. A retiree may eventually need to move to an assisted living facility or encounter financial hardship. If the homeowner decides to move, the loan becomes due. Upon the sale of the home, either you or your beneficiaries are entitled to the remaining equity after repayment of the loan.
Downsizing – i.e. moving to a less expensive home – is another strategy to consider to make ends meet in retirement.
Think about the decision to downsize in these terms. If you live in a spacious home, you probably are paying money to heat areas of a home that are not being used. The rooms where the kids used to sleep are now storage areas, and the backyard has an old swing set that has been abandoned.
Staying in the home can be beneficial if you have a side business, grandchildren or children who stay with you frequently and have many overnight guests. However, many people are selling their homes and moving into condos or apartments which are maintained by property managers.
Making informed decisions
It is important to make a downsizing decision as soon as possible. Moving is stressful, physically and mentally. As people age, it may become more challenging to maintain the larger family home. Once the decision is made to downsize, housing expenses will decrease. Furthermore, proceeds from the sale of a home can be invested to generate income.
A reverse mortgage is appealing to retirees who need money to pay bills, repair the home, or meet living expenses. It can also be a good source of cash for unexpected expenses. Also, reverse mortgages may be appropriate for those who want to slow their withdrawals from their savings or do not want liquidate investments in a market downturn. Downsizing is a more reasonable option in the event of a divorce or job loss.
In most cases when applying for a HECM loan, you must speak with a government-approved counselor. Both a counselor and financial advisor can help determine the costs, benefits and risks of various types of reverse mortgage and downsizing options. They will discuss alternatives and evaluate other options. Finally, an advisor can be alert to possible frauds and scams associated with reverse mortgages.
Every HECM insured by the Federal Housing Authority provides certain ironclad consumer safeguards:
- The borrower is not required to give up title to his home.
- The borrower will never owe more than the home is worth.
- The borrower will never be required to move as long as homeowner obligations (tax payments and insurance premiums) are satisfied.
- The loan will not become due until the borrower dies, moves or sells the home, or fails to meet property obligations.
The most important aspect of the FHA HECM is that “no deficiency judgment may be taken against the borrower or his estate.”
The golden years should be filled with relaxation, family and peace of mind. Making smart decisions about your home in retirement can make all the difference to achieving this goal.