There may be as many reasons to consider a reverse mortgage loan as there are people at least 62 years old — the minimum age to apply for one. That’s because each older American is unique, with diverse financial needs and goals.
The first reverse mortgage in 1961 went to a widow whose wish was to continue aging in her beloved home without the financial burden of monthly mortgage payments. In exchange, she agreed to maintain her home and stay current on her property taxes and homeowners insurance and pay off the loan when she sold or permanently moved out of her home or passed away.
The widow’s agreement with her lender provided her with a perfect financial solution, but a reverse mortgage does far more than just give older homeowners the assurance and security that they can continue to age in place in their current home, so long as they continue to honor their loan terms, which include keeping up with property taxes, insurance, and reasonable home maintenance. In cases, where the home is already paid off or only a small mortgage exists relative to the appraised value of the home, homeowners can convert their excess home equity, up to a certain limit or percentage, into direct, tax-free cash payments that they can choose to receive in a variety of ways.
Many reverse mortgage borrowers use their loan proceeds to pay off large bills or high interest-rate credit card debt, make key home improvements, or meet medical expenses. At the same time, many homeowners use their reverse mortgages not so much to meet an immediate need, but rather to protect a certain retirement lifestyle.
Indeed, many ideal reverse mortgage candidates view the loan as a pro-active and forward-looking way to manage their retirement. Let’s look at three of them:
Ideal Candidate No. 1: Homeowner has no immediate need for money and owes little or nothing on current home
Given the world’s recent recessions, pandemics, and other financial upheavals, it’s not difficult to argue that building up a cash reserve, or starting one, is a smart, pro-active retirement move. While nobody can guarantee future wealth or success, you can increase your odds of achieving it with planning and preparation. As Napoleon Hill, author of “Think and Grow Rich,” wrote in 1937, “Riches don’t respond to wishes. They respond only to definite plans, backed by definite desires, through constant persistence.”
One such plan that can lay a solid foundation for a secure retirement is a reverse mortgage line of credit. After the initial cost (origination fees, upfront insurance premium, etc.) of setting one up, this loan may give you a standby source of tax-free cash if you need it.
Here’s the real upside: If you don’t need it right away, the unused portion of your line of credit continues to grow. This growth rate is the sum of your loan’s initial interest rate and the annual insurance rate you pay on the loan. Thus, if your initial interest rate is 3.0% and the annual insurance rate is 0.5% (the current rate for government-backed reverse mortgages), the growth rate is 3.5%.
To see how powerful this growth feature is, use the Rule of 72, a fast calculation to approximate how long it would take your money to double. This rule usually applies to investments, but the math also works here. So, if you divided 72 by a rate of growth of 3.5%, your line of credit would double in about 20 years (72/3.5% = 20.57 years). Over that time, you could expect a $200,000 reverse mortgage line of credit to double to $400,000, or a $400,000 line to double to $800,000.
That’s a lot of extra financial firepower and peace of mind for retirement. Furthermore, your reverse mortgage line of credit cannot be frozen, reduced, or withdrawn, as long as you continue to honor the terms of your loan agreement. To find out if a reverse mortgage loan is right for you, click here.
Candidate No. 2: Mass affluent homeowner (with investable assets between $100,000 and $500,000*)
In a matter of weeks or sometimes days, the stock market can turn from a raging bull to a ferocious bear, as was the case with the coronavirus-induced stock market crash that saw the S&P 500 index plummet from a peak of 3,386.15 on February 19, 2020 to a low of 2,237.40 on March 23, 2020, about a 34% decline.1
During this breathtaking drop, many retirees, worried sick over the prospect of losing a big chunk of their retirement savings, likely cashed out some stocks to minimize their losses. Their justification was simple: Losing 10% or 15% of a retirement portfolio is a lot more manageable than losing a third — the prospect many retirees were facing had they been invested in the market from Feb. 19, 2020 to March 23, 2020.
Yet, less than a year later, the S&P eventually rebounded to close at a record 3,934.93 on Friday, February 12, 2021, a near 76% increase off the March 23, 2020 market low — a massive gain by almost any investment standard.2
If retirees who had sold into the crashing market — whether out of fear or simply to cover ongoing retirement expenses — had had an alternative source of cash, like a reverse mortgage, to ride out the market downturn, they may have been less inclined to push the “sell” panic button. Indeed, research has shown that the average duration of a bear market is 1.4 years, compared with 9.1 years for the average bull market. The average decline of a bear market is 41%, while the average gain of a bull market is 480%.3
Having a reverse mortgage in place not only can help retirees resist panic-selling, it can help protect them from “sequence of returns risk” early in their retirement. Essentially, sequence of returns risk has everything to do with the timing or the order of when you receive the returns on your investments. If you experience negative returns early in retirement at the same time you are withdrawing money from your investment account, this unfortunate timing can drain your portfolio faster than if those same negative returns occurred later in retirement.
Here’s an example from Kiplinger’s, where each fund started with $1 million and produced the same overall return of 3% after four years.4 Each account owner withdrew $60,000 annually to cover retirement expenses. As you can see, the only difference between the two accounts is the order or sequence in which the returns were recorded, but what a difference! Fund B, which produced strong returns early on, outperformed Fund A by $111,768. Imagine what that gap would be after 10 or 20 years.
Table 1 For Illustration Purposes Only
In a perfect world, there were would be no bearish or negative market years, but that’s just not the way markets work. Savvy investors know this and implement defensive strategies, which include establishing alternative sources of cash, like a reverse mortgage, to ride out periods of market volatility and preserve their retirement portfolios.
Ideal Candidate No. 3: Has a large mortgage balance with many years left before it’s paid off
In the first example, Ideal Candidate No. 1, the homeowner had no mortgage or owed little on it. Yet, a reverse mortgage can be equally ideal for a homeowner with a large, multi-year mortgage, provided there is substantial equity in the home.
After refinancing into a reverse mortgage, money that otherwise would be going to monthly mortgage payments can instead go to cover monthly living expenses, pay off big bills, reduce high-interest credit card debt, or scores of other uses. As the borrower, you are still responsible for maintaining your home and paying your property taxes and homeowners insurance, and the loan also must be repaid after you sell or permanently move out of the home or pass away. This option to delay loan repayment until leaving your home, however, may provide you exactly with the financial freedom and flexibility you’re seeking for your retirement.
Another reason to refinance into a reverse mortgage is simply that the new loan may be better for you — with a lower interest rate and improved loan terms (exchanging monthly mortgage payments for the option of possibly deferring loan repayment for years or even decades). Given the current low interest environment, a reverse mortgage refinance may produce hundreds or even thousands of dollars in interest savings over the life of the new loan.
Working with a reverse mortgage professional can help you crunch the numbers and determine if a new loan works to your advantage. Generally, the principal amount of the new reverse mortgage should be at least five times its closing costs. Plus, the proceeds from the loan should be at least 5% of the amount being refinanced. Developed by the National Reverse Mortgage Lenders Association, these twin refinancing guidelines are known as the 5-5 rule.5
The thread that ties all three ideal candidates together is that they are using their reverse mortgages less to meet immediate needs than to serve long-range, strategic goals, such as building a powerful reserve fund, preserving the longevity of retirement accounts, or realizing thousands of dollars in future savings by leveraging today’s historically low interest rates.
After 60 years, reverse mortgages continue to evolve and expand retirement choices for older Americans. Given this history and ongoing transformation, now may be an ideal opportunity to explore if a reverse mortgage loan can help you achieve a better, more fulfilling retirement.