The Federal Reserve may be taking its time with interest rate hikes, straining the finances of some seniors who depend on investment income. But the go-slow approach also offers a potential silver lining for older Americans: low interest rates make it easier to generate income from a reverse mortgage.
When borrowers take out a reverse mortgage, they receive cash from the lender that represents a sort of advance payment on the equity in the home. The money is generally tax-free, and you can even set up the loan as an equity line of credit, drawing down only what you need.
Lower interest rates can translate into a larger mortgage amount: At an interest rate of 5 percent, a 65-year-old homeowner could take out a reverse mortgage of up to $270,500 on a $500,000 house. When rates are 7 percent, the maximum would be just $182,000, according to the Center for Retirement Research at Boston College.
For many seniors whose home is their largest asset, that difference could be meaningful. The median net worth of householders aged 65 and over is roughly $170,000, according to Census Bureau data. But when home equity is excluded, that figure drops to roughly $27,000.
"There are a large number of households entering retirement that are not going to have sufficient resources to maintain a standard of living and pay medical bills," said Steven Sass, program director at the Center for Retirement Research. If their "biggest source of savings is the equity in their homes, not their 401(k), and there is a way to access that equity, that seems like a good thing to do."
But before you rush to take out a reverse mortgage and savor your good fortune, make sure you understand the downsides and potential risks.
For one thing, interest is added to the outstanding balance every month, and any cash a homeowner receives reduces his or her equity in the house. As a result, when the owner moves permanently or dies, the equity in the home will have been reduced or even used up. If your heirs are not aware that you are taking out a reverse mortgage and are banking on inheriting the property, it can be a nasty surprise.
In addition, the upfront fees on reverse mortgages can be significant, said Barry Zigas, director of housing policy at the Consumer Federation of America.
That may not be a problem if you are able to live in the property for 20 or more years and take the cash in regular installments. If you have to move — always a risk given the health uncertainties that come with older age — or you die, there will be little time for the fees to amortize. (One requirement of a reverse mortgage is that you live in the home associated with the loan.)
You can also get into trouble with a reverse mortgage if you fail to pay property taxes and insurance premiums.
People in financial distress have used reverse mortgages "to kind of keep afloat, and they fell behind on taxes and insurance and went into default," said Sass.
An additional problem can arise if only one spouse signs the loan and the borrower has to move or dies, the surviving "nonborrowing spouse" is at risk of having to move out. (That threat diminished, but did not disappear, after the Department of Housing and Urban Development issued new rules in 2015. They allow surviving spouses to remain in their homes if they meet certain criteria, such as proving that they were legally married at the time the reverse mortgage was originated, own the home and currently live there.)
Another caveat: "Consumers should be especially wary of anyone marketing a reverse mortgage to them in combination with other financial products," Zigas said, like annuities. "Adding the complications of a reverse mortgage to an annuity can make the transaction less transparent to the consumer, load on more fees and ultimately make it less advantageous," Zigas said.
Advertisements for reverse mortgages are often confusing. The Consumer Financial Protection Bureau examined the ads, and found that "many contained confusing, incomplete,and inaccurate statements regarding borrower requirements, government insurance, and borrower risks." The ads also left many consumers confused on basic points, like whether reverse mortgages have to be repaid.
The ads persist, but there are now government safeguards in place to reduce the potential risk. Borrowers have to meet with a counselor before the loan can be finalized, and there are limits on how much of their home's value they can pull out at one time.
Reverse mortgages are not simple, and if homeowners don't properly assess the risks, they can be dangerous. Handled correctly, these loans can make a key difference in an older person's quality of life.
Downsizing is physically and emotionally difficult for many older people, "and even though a lot of people talk about it, they don't seem to do it," said Sass. "A reverse mortgage basically lets you stay in your house."