Reverse Mortgages and Retirement – Part One

A much maligned financial planning tool is the reverse mortgage. And there is good reason why it had a bad reputation. Notice I use the word ‘had’. My position today is there is no reason to simply walk away because of that reputation. It no longer applies.

First, a little background. When buying a house to live in the first time, or the tenth time, people typically seek a forward mortgage. You find the house you want to purchase, you make a down payment, and at the same time enter into an agreement with a lender who will upfront the balance of the purchase price. Think of it as a forward mortgage.

You and the lender will agree on an interest rate to apply to the amount being loaned, and you in turn will agree to make monthly payments until the amount, plus interest, is paid back. There are countless variations on this theme but that’s not the point.

A reverse mortgage, on the other hand, is when you already own the property in question, or at least a substantial percentage of it’s appraised value. The dilemma you might face in retirement is insufficient resources to live your life the way you want to. For years your bucket list of things to do before you die has been to spend three months in New Zealand. But your health is deteriorating, and your retirement income precludes the expense.

So you decide to enter into a negotiated agreement with a lender using your equity in the property to collateralize a loan to you under any one or more of several scenarios. The lender is in no hurry for you to pay them back, largely because their investment in you is protected by the terms expressed in the agreement. You now have the ability to turn one of your bedrooms into that three months in New Zealand. Think of it as a reverse mortgage.

You still own the property, you still get to live there provided you meet certain minimum requirements, like paying for insurance, and paying the property taxes. The lender will get all their money back, plus interest, either from the ultimate sale of the property after you are gone, or from an insurance policy you’ve bought that makes sure the lender is made whole at some point in the future.

Reverse mortgages have a bad reputation because for a long time there was little regulation and financially unsophisticated senior citizens were taken advantage of. Bad things can still happen, but they are far less likely these days. The acronym you encounter is HECM which stands for ‘home equity conversion mortgage’ and is used to describe a Federal Housing Administration (FHA) insured reverse mortgage. That’s where the protections now come into play and no one needs to run in the other direction from a conversation about this retirement planning tool.

The outcome you are looking for is an FHA insured loan which allows you to access a portion of your home’s equity to obtain tax free funds without having to make monthly mortgage payments.

I’ll expand on this idea in the next several weeks so be watching my blog feeds if you are 62 years old or more, and have a substantial equity position in the property where you live.

Tony Kendzior \ June 19, 2019