If you’re retired and recently saw the value of your stock investments plunge, you’re probably facing two bad choices: Live on less until the market recovers or withdraw your usual amount. The catch on making your usual draw is that you need to sell off more of your invested funds to raise the same amount of money. Doing this could cause you to run out of money later in retirement. This dilemma is especially serious in your early retirement years. If you continue to make your usual withdrawals, your savings decrease even more. The ideal course of action is to give your investment portfolio time to recover by reducing withdrawals. This is where a reverse mortgage can help.
With a reverse mortgage, you may be able to navigate smoother sailing in retirement by leveraging the value of your home. According to Shelley Giordano, co-founder (with Torrey Larsen, president of Mutual of Omaha Mortgage) of the University of Illinois Academy for Home Equity in Financial Planning, a reverse mortgage allows homeowners to draw from a line of credit so that they don’t have to tap more of their savings than they planned. And because there are no mandatory monthly mortgage payments, your cash flow will not be diminished.
By borrowing against the value of their home, homeowners can receive a lump sum, fixed monthly payments, or a line of credit to draw on when needed, Giordano says. In this transaction, homeowners aren’t selling their home to the lender — they retain ownership. Unlike a forward (or traditional) mortgage, which requires monthly loan payments, the loan balance on a reverse mortgage isn’t due until the last homeowner dies, moves out of the home or sells it.
Here’s an example of the problem retirees can face in a down market: Say a retiree has $500,000 in his accounts and usually withdraws 4 percent — or $20,000 — a year to meet expenses. If the value of the account drops to $450,000, he faces a choice: Get by on less — 4 percent of $450,000 is $18,000 — or take a larger percentage to receive the full $20,000. By taking the larger percentage, he also increases the risk he’ll use up his savings too early.
But if he has a reverse mortgage, he could use funds from this line of credit until his portfolio recovers.
Giordano has this to say for people who had established a reverse mortgage to hedge against a market downturn: “There’s evidence now that homeowners who prepared for a bear market are avoiding having to sell out of a losing portfolio, which is so devastating. Reverse mortgage services have reported that the draws people are taking from reverse mortgages are significantly larger and more frequent than before the downturn. Folks with reverse mortgages in place are relying on them as a substitute for portfolio distributions.”
Reverse mortgage: not just for monthly income
The vast majority of reverse mortgages are offered through institutions approved by the Department of Housing and Urban Development. The loan itself is insured by the Federal Housing Administration. An FHA-insured reverse mortgage is called a home equity conversion mortgage, or HECM. This type of loan, available for those age 62 or older, allows borrowers to pull equity from their home without paying a monthly mortgage payment. (Like with all mortgages, the homeowner continues to be responsible for paying property taxes and homeowner’s insurance as well as any maintenance of the home.)
Many people think of reverse mortgages simply as a way to receive secure monthly income or perhaps to receive a lump-sum payment. But establishing a reverse mortgage line of credit is another option for homeowners.
Giordano explains that when using the FHA-insured reverse mortgage’s line of credit, no monthly payment for the principal and interest is required for the money borrowed. Other benefits of using a reverse mortgage line of credit include:
• The line of credit can’t be frozen, reduced or canceled as long as the terms of the loan are met.
• The borrower can never owe more on the loan than what the house is worth when the loan is repaid.
• An unused line of credit grows, regardless of the home’s value, owing to the way reverse mortgages are structured. It’s possible for the value of the line of credit to exceed that of the home.
In comparison, a regular home equity line of credit (HELOC) does require monthly principal and interest payments, is subject to more strict lending standards, and isn’t guaranteed by the FHA. There’s also no growth component to home equity lines of credit, and banks can cancel, freeze or reduce credit. In the last recession, for example, some homeowners who thought they were protected with a traditional line of credit were disappointed when the lenders refused to provide credit just when it was needed most.
The market has up and down cycles. When a portfolio rebounds and resumes its growth path, the homeowner could choose to pay down the loan so that the full line of credit is available in case of another downturn. There are no penalties for those payments. Otherwise, the loan can be repaid when the home is sold. The choice is the homeowner’s.
Reducing the expense side of the ledger
A reverse mortgage also can help in a downturn by reducing costs in retirement. In good times, having a mortgage in retirement can be fine. “But the more mandatory obligations you have in a month, the more stress it’s going to put on your savings in bear markets,” Giordano says.
For example, if you have a $100,000 traditional mortgage and you’re eligible for a $150,000 reverse mortgage, you can pay off the traditional mortgage with the reverse mortgage. You’ll eliminate the monthly mortgage payment and have $50,000 credit availability left over.
Reverse mortgages aren’t for everybody. For example, those who plan to stay in their home for only a few years likely wouldn’t benefit.
But for many Americans, a reverse mortgage line of credit is worth discussing with a financial professional. It’s a way to avoid doing long-term damage to savings because of a downturn.
“The house represents about two-thirds of the average American’s net worth,” Giordano says. “That’s a big asset that isn’t being used.”