A reverse mortgage is really just another financial tool to increase retirement income, decrease retirement expenses, or even both. plynty recommends the Home Equity Conversion Mortgage (HECM), which allows borrowers to convert the equity in their homes into a monthly stream of income or a line of credit. The basic requirements to qualify for a HECM include:

  • borrower must be at least 62 years old;

  • the home must be your primary residence;

  • you need to have around 50% equity (but more is better); and

  • you must demonstrate the financial ability to pay taxes and insurance, as well as the financial ability to keep your property in livable condition (HOA fees, maintenance, etc.).

A HECM is the only reverse mortgage insured by the federal government and guaranteed by the Federal Housing Administration (FHA). The current maximum loan amount is $636,150. Visit the FHA’s website for more info on the program.

Reasons to Consider a HECM

Probably the best reason to consider a HECM is that you can increase your guaranteed monthly income by using the tenure payment option of a HECM. Also, these payments are not taxable, unlike some other financial options. Other ways a HECM can improve your cashflow in retirement:

  • Delay using your retirement investments, allowing them to grow longer.

  • Avoid selling investments during a down market.

  • Lessen the impact of sequence of returns risk by delaying the use of invested funds when market performance is below your plan.

  • Eliminate your mortgage payment, freeing up cash for other expenses.

  • If you do not need the money for daily expenses, use it as an emergency cash supply.

  • Possibly delay taking Social Security, increasing your benefit.

  • Pay off consumer debt, decreasing your monthly cash needs.

  • Reduce your taxes by paying the interest on your HECM.

And while owning a home “free and clear” is a dream pursued by many homeowners, doing so also makes it an ideal target for creditors. Having sufficient debt against your home makes it far less likely that creditors will go after your home to satisfy debt. Note: This is not intended to be a way to get out of debt you owe, but to give you better options should some unexpected large debt occur.

Finally, you can buy a new home using a HECM, even if you don’t qualify for a regular mortgage. Thus, it may be the single best way that you can guarantee that you have a roof over your head for the rest of your life. Plus, choosing the right home and having a HECM makes it far more likely that you can have in-home care, should you need it, instead of having to move into an institution. And if your circumstances change, you can sell your home at anytime, and even get another HECM to buy another home. You simply pay off the HECM just like you would any other mortgage.

HECM Cost Considerations

A HECM is more expensive than a standard mortgage — it may cost twice as much to put in place as a standard mortgage. However, most costs are rolled into the mortgage amount. The key fees include:

  • You must receive counseling before you can obtain a HECM and you must pay for this counseling (up to $150, based on ability to pay).

  • As noted above, HECMs are guaranteed by the FHA. These guarantees are paid for by a mortgage insurance premium (MIP) that is part of the loan. The initial fee (IMIP) will be different than the ongoing MIP. If you access less than 60% of the home’s value in year 1, the charge is currently .5%; otherwise it is 2.5% of the loan; it is 1.25% thereafter.

  • Origination fees — based on the home’s value, but the minimum ($2500) and maximum (currently $6000) are set by the government.

  • Closing costs are similar to a standard mortgage – appraisals, title insurance, etc.

  • Ongoing service fees can be as high as $35 per month, but increasingly these fees are being included in the margin rate for the loan.

  • The rate of interest charged is the one-month LIBOR swap rate plus the lender’s margin plus the annual mortgage insurance premium.

These higher costs also offers enormous benefits not available with a standard mortgage. In particular, income is NOT used as a consideration for qualification, so you may qualify for a HECM even if you don’t qualify for a regular mortgage. You may also be able to afford a more expensive home than under standard mortgage regulations.

Additional Considerations

You’ll also need to decide how you want to be paid from your HECM. Disbursement options include:

  1. Tenure payment (lifetime annuity) — Possibly the best option for having a guaranteed income to help meet daily living expenses. The payments under this option do not vary by gender or by whether payments are for one or two eligible borrowers.

  2. Term payment (fixed-term annuity) — Best for those who want some guaranteed income but are less concerned about outliving their funds.

  3. Lump-sum payment — these funds can be used for any legal purpose (e.g., pay off credit card debt/bills, make home repairs or cover unexpected expenses, buy an annuity).

  4. Line of credit — Good as a backup option for those who have other sources of income for daily living expenses.

  5. Combination of two or more of the above options.

As you decide which payment option works for you, keep in mind that you are not required to use the funds in your HECM. The unused balance grows each year, so your available balance becomes larger if you’re not drawing any money out. If you choose to make payments, doing so increases the credit available to you. And the portion of those payments that is allocated to interest is tax-deductible.

A HECM can exceed the value of your home over time. If you owe more than the property is worth at death, you just let the bank have it, and the government makes up the difference so the bank doesn’t lose money. This is the purpose of the insurance premium that is taken from the HECM. Or, your estate or heirs can buy it for 95% of the currently assessed value. If you owe less than the property is worth at death, the estate or heirs can refinance, or sell and keep the difference.

Regardless of how much you borrow or how much the mortgage grows, you can never owe more than 95% of the home’s currently assessed value. However, you need to be aware that a HECM is not a fully guaranteed strategy: there are circumstances under which a reverse mortgage becomes due while the borrower is still alive.

Most homeowners will expect to have to pay off the loan upon their death (or that of their spouse or other qualified party). But there are a number of circumstances where HECM loans become due:

  • Upon the death of borrower(s), unless non-borrowing spouse continues to live there. (Note: Even a non-borrowing spouse who is less than 62 years of age can remain in the house making no payments after the death of the borrowing spouse.)

  • If the borrower(s) doesn’t live in the home for over a year.

  • If the homeowner does not pay taxes and insurance.

  • If the owner does not keep the home in livable condition.

In closing, a HECM is a powerful planning tool. It is not a tool of last resort. So looking at your financial plan — especially your lifelong cashflow™ — is critical to deciding whether this is the right tool for you. Here are some additional questions to consider as you explore whether a HECM is right for you:

  • Is your cash flow from other sources adequate and secure?

  • Are there other reasons to have a reverse mortgage line of credit in place?

  • How long do you plan to stay in the home?

  • What are the terms/payments etc. of your current mortgage?

  • Which is more important to you – the additional income you could have or leaving your home to your heirs?