Perhaps you have heard concerns about Social Security, market downturns, or rising retirement expenses. Perhaps you are wondering how long your savings will last if taxes, insurance, utilities, and home repairs continue to increase.
I understand why these issues can keep you up at night. I am not an alarmist, and I do not believe you should make a major financial decision based on fear. But I do believe timing matters. It is helpful to understand your options before you are forced to make a decision during a financial emergency.
A reverse mortgage may be one tool that helps you create more financial security in retirement. It is not right for everyone. But when it fits your situation, an FHA-insured Home Equity Conversion Mortgage, or HECM, can help you use the equity already built into your home in a thoughtful and coordinated way.
In this article, I will explain three ways a reverse mortgage may help.
Why timing matters in retirement planning
In my recent episode of Reverse Mortgage Radio, I discussed the latest Social Security trust fund projections. The trust fund has been projected to run dry in 2032, compared with an earlier projection of 2035.
If Congress does not act, scheduled benefits could potentially be reduced to 78% of their current projection. That would represent a 22% reduction. I want to be clear: I do not think you should assume that reduction will happen exactly that way. Congress may make changes to payroll taxes, eligibility ages, means testing, or other parts of the system.
Still, the possibility is worth considering. Social Security is an important source of income for many retirees. Having another source of cash may give you more flexibility if benefits change or if your other expenses rise.
The same principle applies to your investments. If you wait until your savings are nearly depleted before considering a reverse mortgage, you may have fewer choices. Establishing a plan earlier may allow you to use your home equity strategically instead of relying on it only as a last resort.
1. A growing line of credit can act as a financial shock absorber
One of the features I like most about an FHA-insured reverse mortgage is the line of credit.
You do not necessarily have to take all available proceeds at closing. Depending on your qualifications and needs, you may be able to leave a portion available in a reverse mortgage line of credit. You can draw from it later when you need money for an emergency, a home repair, medical expenses, or another important purpose.
The unused line of credit can grow over time. For example, if the reverse mortgage interest rate is 6%, the available line of credit may grow at 6.5%: the interest rate plus one-half of one percent. Because the loan has an adjustable rate, the growth rate can change if the interest rate changes.
The line of credit also has protections that make it different from a traditional home equity line of credit. As I explain to clients, the HECM line of credit is FHA-insured, and the available credit cannot be frozen simply because home values or market conditions change. That can provide meaningful peace of mind.
Depending on the rate and how long the line remains unused, it could double over time. Later, you may be able to convert the available balance into monthly payments. For instance, if you establish a line of credit at age 65 and do not need to use it immediately, you may have a larger reserve available years later for in-home care or other needs.
I often describe this as a financial shock absorber. If your furnace fails, your insurance premiums increase, or your property taxes rise unexpectedly, you have another place to turn.
You can learn more about this feature in our guide to how the reverse mortgage line of credit works.
A personal note from Bruce: If you already have a healthy savings account and do not need the money right away, leaving funds available in the line of credit may be worth exploring. The goal is not to borrow unnecessarily. The goal is to create another layer of financial flexibility.
2. It can provide cash during down markets
The second way a reverse mortgage may support financial security is by giving you an alternative source of cash when your investments have declined.
Imagine that you have $600,000 in savings, but a market downturn reduces that balance to $500,000. You still need money for home repairs, a family commitment, travel, or everyday expenses. If you sell investments while they are down, you may lock in those losses.
Instead, you may be able to draw from a reverse mortgage line of credit and give your investment portfolio time to recover.
This is sometimes called a coordinated retirement strategy. It is not about using a reverse mortgage as a last resort. It is about coordinating your home equity, savings, and investment accounts so you have more than one source of cash.
Reverse mortgage proceeds are loan proceeds, not taxable income. That may help you avoid selling an investment and realizing taxable gains at an inconvenient time. It may also help you avoid increasing your taxable income enough to trigger a Medicare surcharge, depending on your circumstances.
I recently met with a client who had sold a substantial amount of stock to help a grandchild. She was now considering a reverse mortgage. The market was not down at that particular moment, but the sale could still create tax consequences and potentially affect her Medicare premiums.
She may have benefited from considering the reverse mortgage first. I share that example because the order in which you use your resources can matter.
A reverse mortgage is not a replacement for sound investment or tax advice. But it can give you another source of cash to discuss with your financial and tax professionals. During difficult market years, that flexibility may help preserve more of your portfolio for the future.
3. Monthly payments can supplement a fixed retirement income
The third way a reverse mortgage may build financial security is by supplementing your monthly income.
This can be especially important if you are widowed or living on one fixed income. You may want to remain in your home because it is familiar, comfortable, and close to your friends, family, pets, and community. At the same time, the costs of maintaining that home may continue to rise.
Property taxes, homeowners insurance, utilities, yard care, snow removal, and repairs can place pressure on a fixed budget. A reverse mortgage may allow you to set up regular monthly payments to help cover those expenses.
Depending on your available proceeds and your goals, you may be able to choose:
- Monthly payments designed to last as long as you live in the home
- Payments for a specific term, such as several years
- A combination of monthly payments and a line of credit
- A lump sum to pay off an existing mortgage or other lien
For example, you might use part of the proceeds to eliminate an existing mortgage payment, set up $1,000 or $2,000 in monthly income, and leave the remaining funds in a line of credit for emergencies.
The right structure depends on your age, home value, interest rate, existing mortgage balance, and financial needs. The reverse mortgage payout options can be reviewed in more detail before you decide whether this approach makes sense.
How the reverse mortgage amount is calculated
The amount available through an FHA-insured HECM is primarily based on three factors:
- The value of your home
- The age of the youngest homeowner
- The interest rate
Generally, an older borrower may qualify for a larger percentage of the home’s value. However, higher interest rates can reduce the amount available. Changes in home values can also affect the calculation.
You should not assume that waiting will automatically result in more money. While you may qualify for a larger percentage as you get older, interest rates or home values may move in the opposite direction.
There are also limits on how much you can receive during the first 12 months. In general, FHA limits the initial disbursement to 60% of the available loan proceeds, with an additional 10% available under certain circumstances. If you have an existing mortgage or other lien that must be paid off, the amount used to satisfy that obligation may exceed the initial 60% limit, subject to the program’s rules.
For a simple example, if you qualify for $200,000 and owe $170,000 on your existing mortgage, the loan may be structured to pay off that mortgage and provide access to an additional portion of the available proceeds. The remaining funds may be set aside for access later.
Because these calculations can be confusing, I prefer to meet with clients in person whenever possible. I want you to see the numbers, ask questions, and understand exactly what the loan would mean for your situation.
Important responsibilities and trade-offs
A reverse mortgage eliminates the required monthly mortgage payment, but it does not eliminate your responsibilities as a homeowner.
You must continue to:
- Pay your property taxes
- Maintain homeowners insurance
- Keep the home maintained
- Live in the home as your primary residence
- Keep your name on the title
You also need to understand negative amortization. Because you are not required to make monthly mortgage payments, interest and mortgage insurance costs are added to the loan balance over time. The balance may grow as you use the funds and as interest accrues.
That is an important trade-off. If looking at a growing loan balance would create more stress than the benefits provide, a reverse mortgage may not be a good fit.
You can review additional details about what a HECM reverse mortgage is, what happens when the loan comes due, and who owns the home.
Is a reverse mortgage right for you?
A reverse mortgage is not for everyone. It may not make sense if you plan to move soon, cannot keep up with taxes and insurance, or do not have enough equity to pay off your existing mortgage.
But it may be worth exploring if you want to remain in your home, eliminate a required mortgage payment, establish an emergency reserve, protect investments during down markets, or supplement a fixed retirement income.
My goal is to help you make an informed decision. I am not interested in rushing you. I have been in the reverse mortgage business for 23 years and with American Liberty Mortgage for 15 years. I want you to understand both the benefits and the limitations before you move forward.
If you have questions, call me directly at 303-513-2748. You will reach me or my voicemail: not a call center. You can also visit Reverse Mortgage Colorado to explore educational resources and frequently asked questions.
A reverse mortgage may be one part of a larger retirement plan. Together, we can look at your goals, your home, your income, and your existing obligations to determine whether it deserves a place in that plan.
Regulated by DORA, NMLS number 409914. American Liberty Mortgage is an equal housing lender.
