It has been over 2½ years since I wrote this article called “Reverse Mortgage – An Underutilized Tool“. Recently, I am getting lots of questions about reverse mortgages, even from clients with significant investment portfolios. In other words, reverse mortgages are not necessarily a tool of last resort. The first thing to understand about reverse mortgages is that it’s the only way to borrow money against the equity in your home without ever having to make a payment. The loan, plus interest, gets paid back when the last remaining homeowner passes away or moves out of the home. Any remaining equity after paying off the loan passes to the homeowner’s beneficiaries. The loan is also non-recourse, so you can never owe more than the value of the home.
My 2014 article made the point that reverse mortgages are getting more respect from academics as a smart way for many retirees to supplement their retirement incomes. This week, I read two articles that added to prior research and shed some light on specific situations where reverse mortgages often make sense. The first was in the Journal of Financial Planning, which asked:
Do reverse mortgages or immediate annuities offer better retirement Income security?
The author explained that one payment option with a reverse mortgage is monthly payments for life (as long as the retiree continues to live in the home). The other way to get guaranteed “payments for life” is to use a chunk of your investible assets to buy an annuity. The two income streams are not taxed in the same way. Immediate annuity payments are partially taxable, while reverse mortgage payments are not. There are several other differences, such as the factors that drive the amount of the monthly payments (e.g., interest rates, longevity projections, etc). The question that everyone wants to know is…for those who need to supplement their retirement incomes, and have both home equity and retirement savings, which is the better source to tap?
The author of this article (Mark J. Warshawsky, Ph.D., a visiting senior fellow at the MIT Golub Center for Finance) reports that an annuity is generally the better solution for those who are older (e.g., age 75+) and tends to makes more sense for single men. This is because men have shorter life expectancies (compared to women), which enables the insurance company to offer higher annuity payments. The reverse mortgage is generally slightly more favorable to younger retirees, females, and especially “younger” retired couples (e.g., those in their 60s or early 70s). Naturally, the best option for a specific household will depend on interest rates at the time, so get a quote on both an annuity and a reverse mortgage if/when you are considering such a move.
The second article appeared in yesterday’s Wall Street Journal. It made the case for:
Setting up a reverse mortgage “Standby” Line of Credit early in retirement, just in case you need it later.
The reason for doing this is the line of credit cannot be cancelled by the lender and the available credit line automatically grows each month. The credit line can be tapped as needed and/or converted into monthly payments later in retirement. The article gave an example of a 62-year-old homeowner with a $400,000 home. The initial credit line was $200,668. The available credit line grows at the current interest rate on the loan of 5.7%. You may think that rate seems high, but keep in mind you are not accruing any interest if you are not carrying a loan balance. The available credit line would grow to over $600,000 after 20 years at today’s interest rate and could then be tapped or converted to an income stream of nearly $5,000 a month. The biggest drawback of this strategy is the initial cost to set up the loan. The initiation fees for the loan described above were close to $9,000.
This strategy has been promoted in various academic financial journals over the past few years. Research shows that it significantly improves retirement outcomes when retirees use the line of credit instead of taking withdrawals from their portfolios during market downturns. Retirees in this scenario simply take their usual monthly distributions from the reverse mortgage line of credit to give their investment portfolios time to recover.