If your retirement income needs are greater than your income, there may be ways you haven’t considered that could cover the shortfall. Home equity, for example, is an asset you may have overlooked, but you can borrow part of that equity tax-free to enjoy a more comfortable retirement. One way seniors aged 62 and older can access their home equity is with a federally insured reverse mortgage, known as a Home Equity Conversion Mortgage or HECM.
Now may be an ideal time to integrate an HECM into a retirement income plan as home prices in many regions have reached all-time highs, and interest rates are still favorable. Seniors pay no income taxes on money they borrow and can use it in a myriad of ways — to improve monthly cash flow, cover emergencies like major home repairs or unanticipated health care costs, reduce or prevent the need to sell stocks during a market downturn, and make the dream of aging in place a reality.
Understand the benefits
Unlike a traditional mortgage, which is considered a forward loan, a reverse mortgage doesn’t involve making payments to a lender. Instead, you hold onto the title, and the lender uses your home as collateral to make loan payments to you. To qualify for the mortgage, you must meet the age requirements and have equity in your home equal to 50% or more of its current appraised value.
You aren’t required to pay back the equity or the interest as long as you live in the home. The loan balance grows and your equity in the home decreases as you borrow money. The interest due is simply rolled into the loan balance.
The loan must be repaid when you move out, pass away, or sell the property. The bank or loan company can foreclose only if you fail to meet certain obligations, such as keeping the home in good repair and paying property taxes and homeowner’s insurance premiums.
If your home value drops below the loan amount, you won’t lose your house. The federal mortgage insurance on the HECM loan protects you and pays the difference. This coverage also protects you as a seller as long as the sales price equals or exceeds the appraised fair market value.
Lenders typically loan borrowers between 40 and 60% of their home’s appraised value. Typically, the older you are, the higher the percentage.
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There are different ways to receive your money. The choices generally include a lump sum, a monthly payout, or a line of credit with a checkbook.
Evaluate potential disadvantages
There are several disadvantages to reverse mortgages that retired homeowners will want to consider. First and foremost, you have to decide how comfortable you are with having debt and using your home as collateral for a loan. Of course, there’s no right or wrong answer. It’s a very personal decision.
If you intend to leave your home to your kids, a reverse loan may not be the right product for you. But never say never. At some point, you may have to weigh the benefits of using your home equity for added financial security against providing a generous inheritance for your children.
If you’ve had a forward mortgage, you know the application and underwriting process won’t be a walk in the park. There are cost considerations too, including one-time origination fees and closing costs. You’ll also have ongoing expenses, such as mortgage insurance premiums, service fees, and interest charges, all of which are added to your loan balance each month. These ongoing costs compound, which means you’ll incur interest and fees on top of the interest and fees that were added to the previous month’s loan balance. Some people feel home equity is precious and don’t want to “waste it” by covering these costs. If you share that feeling, a reverse loan may not be a good fit for you.
Why now?
Rising real estate values and favorable interest rates have prompted more retirees than ever to tap into their home’s value. HECM volume hit a record high in 2021. Financial journalists have also started touting advantages of these loans. If you use Google
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Be sure to educate yourself and practice due diligence before you apply for a reverse loan. When you’re planning for retirement income, making prudent financial decisions is essential.
