Published by Daniel Morrison, Founding Partner and Wealth Advisor
Imagine this: you are nearing retirement and worried about whether your savings will last through your golden years. Then your neighbor mentions a reverse mortgage and how you can get cash payments in exchange for your home’s equity, providing an income stream you can live off of in retirement. It sounds like the answer to all your retirement cash flow problems, but is it just too good to be true?
Before making any rash financial decisions, use this guide to learn more about reverse mortgages and how they can be used in your retirement plan.
Reverse Mortgage Basics
A reverse mortgage is a type of home equity loan, created specifically for those 62 and older who own their home outright or have a small balance left on their mortgage. A reverse mortgage allows you to borrow against the accrued equity in your home, essentially giving it back to the bank in exchange for either a monthly payment or lump sum.
You are not required to pay back the loan until you sell your house, die, or permanently move out. You are, however, still required to pay property taxes and homeowners insurance. The amount you receive through a reverse mortgage will depend on your age, the value of your home, and current loan interest rates.
Risks
Now that you know the bare minimum about reverse mortgages, let’s look into why you might want to avoid them.
They Aren’t Cheap
If you’re using a reverse mortgage as a way to cover retirement expenses, keep in mind that your up-front costs will be hefty, anywhere from 3-5% of the loan amount.[1] This includes an origination fee, appraisal fee, closing costs, and a required mortgage insurance premium.
When you invest your money, compound interest is on your side, but with reverse mortgages, it works against you in a major way. As its name implies, it’s the reverse of a regular mortgage. Instead of your interest payments decreasing as you pay down the loan, your outstanding interest payments actually grow as the bank buys back your home equity. For example, let’s say you have a $100,000 reverse mortgage that you decide to take as a lump sum at a 5% interest rate. After your first year, your loan balance will be $105,116, and after 10 years, it will be sitting at $164,701.[2] The interest eats away at your equity, meaning you own less of your home as time goes on.
They Hurt Your Heirs
If you were planning to leave your home as an inheritance for your children or grandchildren, a reverse mortgage will make that impossible. If the interest has racked up enough by the time you die, every penny from the sale of the home could go to the reverse mortgage lender. If your heirs decide to keep the home, they will be responsible for paying off the full value of the loan, even if it’s higher than the home’s fair market value.
You Could Outlive Your Mortgage
Just as there is a very real chance you could outlive your retirement savings, you could also outlive your reverse mortgage. What happens when you have borrowed the maximum amount and no longer have money coming in? Other living expenses aside, you will still need to pay for taxes, insurance, and utilities. If you default on those payments, you risk foreclosure. This leaves you with nowhere to live and no money to live on, a worst-case scenario for sure.
Alternative Options
It’s not all doom and gloom. If you feel like a reverse mortgage is your only way to fund retirement, here are some other options to consider.
Downsize
If you are willing to make some changes, downsizing your home or moving to a cheaper area could drastically decrease your living expenses and stretch out your retirement savings. When you sell, you can capitalize on the equity you’ve built and stash away the profit as a source of retirement funding. A smaller home will also have lower maintenance costs, property taxes, and utility bills. Another option to consider is renting instead of buying, which could free up extra cash that can be invested or spent on other goals.
Investigate Other Assets
Even if your retirement savings seem meager, you might be able to maximize what you have by making a few wise decisions. Consider the following options:
- Extend your retirement timeline by a few years.
- Maximize contributions to your employer-sponsored retirement plan and IRAs.
- Work part-time during retirement.
- Delay retirement until you have maximized your Social Security benefits.
Making small adjustments to your financial plan may make a significant difference in the long term.
Rely on a Professional
At Jacob William Advisory, we have experienced wealth advisors to guide you through retirement, helping you address your worries, reexamine your goals, and build a solid retirement plan. Remember that in most cases a reverse mortgage should not be used unless you have experienced a financial emergency and have no other assets available. Take our retirement readiness quiz to find out how prepared you are for your golden years.
If you want to learn more about your retirement options, or if you want advice on creative ways to reach your goals, contact our office by calling 410-821-6724, emailing [email protected], or schedule an appointment at https://www.jacobwilliam.com/insights/#contact.
About Dan
Daniel Morrison is a Founding Partner and Wealth Advisor of Jacob William Advisory, a wealth management firm whose sole mission is to service their clients’ needs beyond their expectations. Dan Morrison has 27 years of industry experience, and for the past decade, he has been committed to building Jacob William Advisory into one of the foremost wealth advisory firms. Dan graduated from Towson University with a bachelor’s degree of finance in economics and obtained his master’s degree in finance from the University of Baltimore. He is a CERTIFIED FINANCIAL PLANNER™ professional and holds the Chartered Financial Consultant® (ChFC®), Chartered Life Underwriter® (CLU®), and Chartered Advisor in Senior Living® (CASL®) designations. He and his wife Beth reside outside of Baltimore, Maryland, and have three wonderful children. Dan is involved in his church and he enjoys spending time with his family, playing golf, and sailing. A good book is also never far from his reach. Learn more about Dan by connecting with him on LinkedIn.
[1] https://reversemortgagealert.org/reverse-mortgage-rates/
[2] https://www.mortgagecalculator.org/calcs/ReverseMortgage.html
