Reverse mortgages are not right for everyone. If you’re a senior with cash flow issues, you should know if this makes sense for you.
Are you a senior looking for more income? There are two famous “cash flow” solutions for seniors: reverse mortgages and annuities. But you’ve probably heard:
- Reverse mortgages are horrible.
- Annuities are a terrible deal.
For the most part, these statements are true. The first part of my “Senior Cash Flow” series has to do with reverse mortgages. I will give you some straight talk on reverse mortgages, including important features and considerations that may help guide you in your decision-making process.
First and foremost, some big picture concepts:
The average person should not get into a reverse mortgage. The average person is often misled about the features of a reverse mortgage.
Reserve mortgages are not a free pass for a spending spree or a carte blanche for throwing out your disciplined budgets, just because more cash flow is supposedly coming in. This is usually what people get tricked into believing by an over-eager salesperson, who will only paint a rosy picture of what’s ahead.
If you have to go into a reverse mortgage, you should have exhausted every other option for money/income (annuities, home equity line of credits, traditional loans, etc).
So now, let’s talk about the good, the bad and the ugly on reverse mortgages, specifically HECMs (Home Equity Conversion Mortgages) which represent about 90% of reverse mortgages out there. These have a federal insurance protection with about a 630k limit on what you can pull out, sufficient for the average person.
- Salespeople will tell you how HECM s are so much better and protect the consumer, which is true, but that is not the full picture.
Reverse Mortgages: The Good, Bad & Ugly
When It Makes Sense:
- A reverse mortgage only makes sense if you are desperately in need of income RIGHT AWAY (i.e. for medical bills). Please don’t use this “extra money” for vacations, increasing your standard of living, or to put down on a shady “investment”. Why? Because this is a loan – you are spending money you technically don’t have. Once again, exhaust all other options first.
- The older you are and if you own the house outright, or close to paying it off (have high equity), the higher amount (or income) you will get. You can either choose a lump sum or a tenure (lifetime cash flow). Maximum total benefit is 60% of the value of the home, per HECM standards. So if you have a home and equity worth $500,000, you have about $250,000-300,000 that’s usable.
- Remember that the loan comes at a higher interest than a traditional loan. You will pay dearly for it, with instant costs such as the origination fee, closing costs and HECM insurance. What’s left of your equity after fees will be much less than you thought you had to work with.
- Low qualification hurdles (bad credit? no credit? OK!) – get your lump sum or lifetime cash flow (tenure) right away.
- You don’t need to pay back the loan until death or when the house is sold, even if you’re deeply underwater (the loan value exceeds value of the home). Thanks to HECM insurance, your heirs will also never pay more than what the house is worth and if the loan is less than the selling price, you get to pocket the difference. This is good on paper but reality isn’t as rosy (more on that later).
- If you don’t care about the principal (your home) being at risk, or ownership (i.e. you have no heirs), you can have a nice cash flow for the rest of your life, while knowing you won’t be kicked out of your home.
- Know that it takes about 28-30 years before you get all your money back in tenure payments, not accounting for interest. But if you’re 62 years old with a history of longevity in your family, odds may be in your favor that you may net more money than you put in (though this doesn’t account for inflation). In Southern California, a home can be 10x the value in 30 years.
- Let’s put some numbers to this scenario. A $500,000 home can get you about a $275,000 line of credit, which means about an $18,500 a year annuity. If you live till 90, you break even. If you live till 100, you will have made all your money back and then some.
- Can work if you need the cash in a bind, but are able to pay the loan back ASAP or in a few years when you can pay off the reverse mortgage plus the accumulated interest (i.e. if you’re expecting an inheritance), this could make sense. With HECM s there are no prepayment penalties (other reverse mortgages don’t necessarily have this guarantee).
- This is not free money. You’re paying dearly in punitive, sky-high interest rates and high fees out the gate. Only with a lump sum will you get a fixed rate. Otherwise, with the income option, it’s adjustable and you’re vulnerable to market forces. The adjustable is slightly better and you may have a better chance to not be severely underwater, but that’s not saying much.
- The bank or institution now owns your home functionally. Salespeople will say otherwise due to new laws and the HECM insurance, but the reality is they’re in the power seat financially thanks to the initial structure of the deal, which is always protecting the interests of the lender.
- At the event of a death, the heirs are given an option to purchase back the house by settling the loan. Thanks to the HECM federal insurance you paid for, the buyback price is never more than what the house is worth on the market. The government covers the rest. However, in practice, the loan amount is usually way higher than the house’s worth due to the initial terms and compounding interest. You will likely not get money back. (Remember that if the loan amount is below the house’s market worth, you get to keep the difference. Hardly ever happens though.)
- If your non-spouse loved ones are living with you, they will be kicked out of the house if they can’t afford to “buy back” the house. Pretty ugly. In the past, your spouse would have also been mercilessly kicked out but this has changed in recent years, thanks to HECM insurance. However, make sure to read the terms of your agreement. HECM s are 90% of the reverse mortgages out there but 10% are not. Long story short, the spousal safety net may be there but you are likely paying handsomely for it.
Marc Ang (Mangus) is a financial planner based in Claremont, CA, focused on spreading the gospel about responsible, educated and smart financial planning.