Reverse mortgages have earned a rotten rap, evoking images of elderly widows forced from their homes by evil bankers. But a lot has changed since these instruments were created in 1989. In the past two years, the Federal Housing Administration has lowered their costs and built in new consumer protections — most notably by limiting how much investors can borrow against their home’s value. Now, several prominent financial advisors and academics say that if used correctly, a home equity conversion mortgage (HECM) can help make retired clients’ assets last decades longer.
For instance, writing in the Journal of Financial Planning, veteran planners Harold Evensky and John Salter suggest that advisors use the loans as a form of portfolio insurance. Essentially, the extra income lets retirees avoid selling securities during down markets; with less volatility risk, the nest egg is likely to last longer. “Reverse mortgages do have a place in mainstream retirement distribution planning,” the authors write, “and have a significant impact on the probability that some clients will be able to meet their predetermined retirement goals.”
The key is not making an HECM a last-resort source of income for basic living necessities. Rather, experts say, advisors can use them to supplement other retirement income and improve living standards. “For many clients, the problem is simply that they are house-rich and cash-poor,” notes Michael Kitces, director of research at Pinnacle Advisory Group in Columbia, Md. “So the choice is sell your house, move, leave your friends and give up your lifestyle — or get a reverse mortgage.” The biggest risk attached to an HECM is that if a client can’t cover property taxes and insurance, the lender can foreclose. For clients who have income-producing assets beside their home, that risk is far smaller.
Under new rules implemented last fall, lenders calculate a maximum loan amount based on the investor’s age (which must be at least 62), the home’s value and prevailing mortgage rates. The older the borrower, the higher the property value and the lower the rates, the more money the client can get. Assuming the borrower withdraws no more than 60% of the loan amount during the first year, up-front fees are 0.5% of the home’s value, down from 2% in the bad old days. Borrowers also pay an annual mortgage insurance premium of 1.25% of their loan balance.
Marguerita Cheng, CEO of Blue Ocean Global Wealth in Bethesda, Md., points out that income from a reverse mortgage can allow retired clients to wait until age 70 to start collecting Social Security, when payments reach their maximum. Furthermore, because income from reverse mortgages is tax-free, some advisors use the loans as part of a post-retirement tax saving strategy; the HECM income can keep clients from withdrawing too much from IRA or 401(k) accounts. “If you take too much out of a qualified plan, it can kick the client into a higher tax bracket,” says Cheng.
She’s a big believer in the lifestyle-enhancing potential of reverse mortgages for retirees. One of her clients, a widow, wanted to do some work on her house, whose mortgage was almost paid off. Cheng helped her get an HECM of $75,000. “It was there for emergencies and opportunities, and to pay for upgrading her home,” says Cheng. “At that age, you don’t want to take out loans that you have to repay.”
The bottom line, she says, is that reverse mortgages are no longer only for retirees in dire straits. Advisors “should be looking at every aspect of income, including home equity,” says Cheng.