Many homeowners in or near retirement face a quandary. Their wealth is tied up in their home--two-thirds of the average retiree's net worth is home equity--yet they'd rather not tap that wealth by selling their house and downsizing.
One versatile solution is a reverse mortgage. It lets you stay put, ditch your mortgage payment (if you still have one) and tap your home equity. The money you borrow can be used however you like--to supplement retirement income, to renovate your home or to cover health care costs, for example. Divorcing spouses can use a reverse mortgage to, say, help one spouse keep the house and the other buy a home. With a reverse mortgage "for purchase," you can even buy a retirement home. The loan comes due when the last surviving borrower dies, sells the home or leaves for more than 12 months due to illness. You'll never owe more than the value of your home when you or your heirs sell it to repay the reverse mortgage.
Options for taking the money
Your borrowing power depends on your age (or the age of the younger spouse), the value of your home and current interest rates. With a rate of 5%, a 62-year-old borrower can qualify for an initial payout (the principal limit) of 52% of the home's value (up to the current
Because, in effect, you're receiving loan advances, not income, the money is tax-free. It won't affect what you pay for Medicare, how your
Borrowers have several payout options, depending on their goals. A line of credit offers the most flexibility. You can borrow the maximum amount for which you qualify during the first two years, tap the line periodically to supplement income, or hold the line in reserve. You'll incur interest only on the outstanding balance. Meanwhile, the untapped portion of the line compounds at the same rate at which interest is charged on any balance. If interest rates rise, more interest will accrue on the outstanding balance, but the untapped portion of the line will grow in tandem. That's another reason to take a reverse mortgage with a line of credit sooner rather than later. Over many years, the line of credit can increase to far more than the original amount.
Retirees will have the greatest probability that their resources will outlast them if they avoid taking money (or take less) from their investments in a down market, especially early in retirement, according to research by Pfau and others. In a month or year when your investments have lost value, you could take withdrawals from the line of credit instead. When your investment portfolio has recovered, you can begin withdrawing money from your investments again, possibly repaying the line of credit and rebuilding its insurance value.
Borrowers who want guaranteed income can also choose fixed monthly payments--possibly in addition to the line of credit. You can take fixed payments in one of three ways.
A term payment will provide fixed monthly payments for a certain period. You could use it as an income bridge to, say, postpone taking
A tenure payment provides fixed monthly payments based on your age (and a life expectancy of 100), and payments continue until the last borrower dies, sells or leaves the home. The term or tenure payment will remain the same even if your loan balance grows beyond the value of your home.
A reverse mortgage with tenure payment can be a compelling alternative to an immediate fixed annuity if you plan to stay in your home for life, says Pfau. Whereas an annuity requires a large up-front payment taken from other assets, a reverse mortgage requires only that you cover the up-front costs, which you can pay from the loan proceeds. The payment calculation doesn't penalize women or couples for their longer life expectancies compared with single males, as annuities do. Plus, payments from the reverse mortgage are tax-free, whereas annuity income may be taxable.
A modified term payment or modified tenure payment combines either payment type with a line of credit. This approach provides guaranteed income and flexible access to a growing line of credit. You'll continue to receive the term or tenure payment even if you use the entire line of credit.
The least-flexible form of payout is a lump sum. This is a one-and-done deal. You can take part or all of your principal limit to, say, renovate your home, buy long-term-care insurance or pay the tax bill if you convert traditional IRAs to
Shop for the best terms before you choose
Before you shop for a reverse mortgage, it's a good idea to discuss with a financial adviser how one would fit into your retirement plan. Look for an adviser who has earned the retirement income certified professional (RICP) designation from the
An adviser can discuss options for payouts with you, or you can run what-if scenarios with the reverse mortgage calculator at the Mortgage Professor website. See how much you qualify for based on various factors and receive a summary of competitive offers from participating lenders. You can give a lender your contact information to follow up with you, or you can use the summary to compare offers from other lenders. To find lenders in your state, visit Reversemortgage.org, the website of the
Get at least three quotes, and make sure each one shows a selection of margins and illustrates how your choice affects your up-front cost and payout. The
Lenders charge a fixed interest rate on a lump-sum payout and a variable rate on all other types of payouts. Rates are based on an underlying index--typically the one-month or one-year LIBOR--to which lenders add a margin of 2.5 to 4 percentage points. In general, the higher the margin, the lower the origination fee. You can negotiate a credit against your closing costs if you agree to accept a higher margin. A typical interest rate on lump-sum payouts is 5%. Draws from a line of credit have variable rates, recently ranging from 5% to 6.5% using the one-month LIBOR.
Some loan officers' compensation may be linked to the amount that you borrow immediately, so they may suggest taking more money sooner. Don't fall for that. Plus, reverse mortgage lenders can't legally sell you other financial products, such as annuities.
Keeping your end of the bargain
You must maintain your home and pay property taxes, hazard insurance premiums, and homeowners association or condo dues, or you'll risk defaulting on your loan. If the lender determines you can't handle those costs, it will set aside funds from your payout in an escrow account and pay those bills.
After the borrower leaves the home, lenders must allow an eligible nonborrowing spouse or committed partner to stay. That could still leave survivors in the lurch because they can't take any more money from the reverse mortgage, but they must still keep up with taxes, insurance and maintenance. You'll never owe more than the value of your home when it's sold to repay the reverse mortgage. If your home sells for more than you owe, you or your heirs keep any leftover equity. If your heirs want to keep the home, they can refinance the reverse mortgage, or they can pay the outstanding debt or 95% of the home's appraised value, whichever is less.
What you need to know
To be eligible for a reverse mortgage, borrowers must be at least 62 years old, named on the title of the home and live in the home for more than half of the year. The maximum payout, or principal limit, for which you'll qualify depends on your age (or that of a younger co-borrower or a nonborrowing spouse, who must meet certain criteria to be eligible), as well as the current interest rate and the appraised value of your home, up to a maximum of $636,150. Some lenders offer larger, "jumbo" reverse mortgages.
You must get financial counseling to ensure that you can meet your obligations as a borrower. To find a housing counselor certified by the
If you have a mortgage, you must pay it off from the loan or other sources. You can withdraw no more than 60% of your principal limit in the first year, unless you need more to pay off existing mortgage debt or make repairs required by the lender. Reverse mortgages are insured by the
You'll accrue annual mortgage premiums at a rate of 1.25% of the amount you borrow, and interest charges will accrue on any outstanding balance--though no principal or interest payments are due until the home is sold.