The reverse mortgage has won some new respect.
A decade ago, most financial advisers would roll
their eyes at the mention of reverse mortgages, loans that give
homeowners an advance on their home equity and allow them to delay
repayment until the home is sold. Such products, these advisers used to
say, weren’t for their clients, but rather for those who didn’t prepare
financially for retirement.
New safeguards in recent years,
however, have led many advisers and researchers to change their minds
about reverse mortgages. Indeed, many now are exploring when and how to
use them in financial plans.
One important change, the Reverse
Mortgage Stabilization Act of 2013, prevents homeowners in most cases
from taking all their equity at once—roughly 40% of the total amount
that can be borrowed is unavailable until a year after the initial loan.
Other recently enacted regulations require homeowners to demonstrate
they are able and willing to pay their property taxes and home
insurance. And there are new protections for the nonborrowing spouse.
Recent
policy changes “should make the product safer for seniors in the
future,” says Stephanie Moulton, an associate professor at Ohio State
University and co-author of a 2015 paper on reverse mortgages published
in the Journal of Urban Economics. Prof. Moulton estimates that such
changes as limiting how much equity borrowers can extract upfront could
cut the default rate on reverse mortgages in half. (In 2014, nearly 12%
of reverse-mortgage borrowers in the federally insured Home Equity
Conversion Mortgage program were in default on their property taxes or
homeowners insurance.)
“Over time, these changes may encourage
larger banks to re-enter the market, further increasing the credibility
of the product and potentially lowering costs,” Prof. Moulton says.
Of
course, there are still risks, including spending the proceeds too
quickly and suffering losses if the proceeds are invested, as pointed
out in a 2015 paper written by Wade Pfau, a professor at the American
College of Financial Services in Bryn Mawr, Pa., that favored the use of
reverse mortgages in a retirement-income plan under the right
circumstances.
While acknowledging the risks, Prof. Moulton says
that “one of the advantages of the federally insured reverse mortgage,
the HECM, is that the government assumes some of the risk for the
borrower.” For example, she notes that HECM borrowers can never end up
on the hook for negative equity. If the balance on the reverse mortgage
ever grows to exceed the value of the home, the federal insurance covers
the difference.
Here’s a look at some of the reverse-mortgage strategies financial planners suggest:
Taking a lump sum
Borrowing
enough of the equity in a house in a lump sum to pay off an existing
mortgage is one of the most frequent uses of a reverse mortgage, says
Prof. Moulton. More than 60% of reverse-mortgage borrowers have used the
proceeds for this purpose, according to her research. “This actually
may be a pretty smart strategy,” she says.
Prof. Moulton cites a
recent report by Harvard University’s Joint Center for Housing Studies
that found that nearly 40% of seniors age 65 and older carry a mortgage
today, a rate that has more than doubled since 1992. “Using a reverse
mortgage to pay off a forward mortgage frees up monthly cash flow to a
household,” she says. “Essentially it has the same effect on a household
budget as receiving a monthly annuity payment.”
But lump-sum
borrowing can go wrong. Harold Evensky, chairman of Evensky &
Katz/Foldes Financial, a wealth-management firm based in Lubbock, Texas,
generally advises against using a lump sum as leverage to increase
debt—as a down payment on a second home or vacation home, for instance.
“There may be circumstances that justify the strategy, but it’s not
something that should be considered without carefully considering the
potential risk,” he says. “The risk is overleveraging,” he says—taking
on more debt than you can afford to pay off.
And even if that
isn’t the case—if the homeowner spends the borrowed money without
incurring additional debt, say on a vacation or a car—spending the
equity in a home this way deprives the homeowner of a valuable financial
cushion, he says.
Opening a line of credit
Increasingly,
advisers are suggesting that homeowners establish a line of credit
through the HECM program whether they need the money immediately or not,
because it can be used in several ways, as the need arises, to protect
savings or even increase income in retirement.
A line of credit
makes more sense than borrowing a lump sum and keeping it in reserve,
says John Salter, an associate professor at Texas Tech University who
has co-written papers with Mr. Evensky on reverse mortgages. That’s
because, due to the intricacies of reverse-mortgage terms, the unused
portion of a line of credit grows over the years, giving the homeowner
access to more cash.
Shelley Giordano, chairwoman of the Funding
Longevity Task Force, a Washington, D.C.-based industry group that
promotes the use of home equity as a tool for retirement income,
suggests setting up a reverse-mortgage line of credit as a way of
protecting retirement funds from fluctuations in the financial markets.
Here’s
the idea: In a bear market, homeowners can borrow funds as needed
through the line of credit rather than withdrawing money from their
investment portfolios. Withdrawals from a portfolio in down markets lock
in losses and leave less money to grow when markets rebound. By
borrowing instead, homeowners give the portfolio a better chance to
recoup its losses when markets turn around.
Once the portfolio
recovers, it can be used to pay off the line of credit, which is then
fully available the next time cash is needed in a bear market. Ms.
Giordano notes an HECM line of credit “cannot be canceled, frozen or
reduced regardless of what the home value does in the future.”
An
HECM line of credit also can be used as a source of income for those who
want to delay applying for Social Security benefits and so increase
their monthly payout when they do start taking benefits, Ms. Giordano
says. After you apply for Social Security, you can stop taking money
from the line of credit and, if you want, pay the loan back.
Because
income from a reverse mortgage isn’t taxed, experts say an HECM line of
credit can also be used—in place of taxable withdrawals from retirement
accounts—to avoid tax-bracket creep, as well as the higher Medicare
Part B and Part D premiums that can result from higher incomes.
Ms.
Giordano also suggests using a reverse-mortgage line of credit to pay
taxes due on Roth IRA conversions. In the conversion process,
distributions from IRAs are taxed as ordinary income, and experts often
recommend paying those taxes with funds outside the IRA, because using
money from the IRA for that purpose generates even more taxes.
Mr. Evensky says the usefulness of reverse mortgages belies the negative impression some people still have of them.
“I
believe most criticisms relate to a myopic view of the product that has
not been reviewed for decades,” he says. “Unquestionably there can be
misuses of the product. But the problem is the use, not the product.”
Culled from The Wall Street Journal
