Reverse mortgages may be helpful in retirement ... if you mind the pitfalls

People who need more cash in retirement these days might be considering a reverse mortgage.

The offer is tempting.

Homeowners who are age 62 or older can convert part of the equity in their home into cash instead of having to sell. 

But there are disadvantages, such as complexity of the loans and their significant expense. 

It's called a reverse mortgage because the payments for this loan actually work in reverse: You don't repay the lender until you permanently move out or die. As long as you continue paying taxes and maintaining the home, you cannot be evicted. 

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Payments vary widely in different reverse mortgages, from a one-time payment, or by leaving funds in a line-of-credit that can grow over time if unused, or as monthly payments, or some combination of options.

Most popular is the variable-rate home equity conversion mortgage, according to Wade Pfau, professor of retirement income at the American College, in Bryn Mawr, Pennsylvania. This type of mortgage, aka an HECM, is insured by the Federal Housing Administration and offers several payment options. 

Other arrangements are the proprietary reverse mortgage, a private loan backed by a company, and the single-purpose reverse mortgage offered by some state or local government agencies. 

When you're considering a reverse mortgage, ask yourself if the house will work for you the rest of your life, says Carolyn McClanahan, a physician and certified financial planner who is founder and director of financial planning at Life Planning Partners in Jacksonville, Florida. Scout other possibilities, she advises, such as selling the house so you can use the money for a less-expensive property or to rent.  

With a reverse mortgage, you have to be sure you can afford your home forever, McClanahan says.

On the plus side of a reverse mortgage, there are two "pros":

• You can tap equity in your home without having to sell.
• You can keep the title to your home.

On the minus side? Here are the "cons":

• High fees: The biggest cost is an initial mortgage insurance premium equal to 2% of the appraised value. "The origination fee might be higher than with a traditional mortgage," Pfau said.
• No one living with you under the age of 62 may be a borrower on the reverse mortgage.
• You leave less money to your heirs.

Applications for reverse mortgages rose 15% in March from the previous month as people turned to the loans to avoid tapping retirement investments in a down market.

And there's another potential reason we'll see more interest in reverse mortgages. Retirement communities and assisted living facilities have become more common in recent decades.

However, in the age of Covid-19, Americans may decide that large groups of older people living together in one place might not be a good idea after all, McClanahan says. This could mean that more people will try to age in place. 

Having more equity built up in the home than in savings is a common reason for turning to a reverse mortgage.

In other words, some people are "home-rich and cash-poor," Pfau said. "They might not have a lot of savings."

Several factors should be in place for a reverse mortgage to work.

"[For] an older person who has a home that is aging-friendly in a community that's also aging-friendly, it's probably an OK idea," McClanahan said.

A good strategy could be taking some of the initial money and putting it into modifications to make the home adaptable for someone as they age.

Someone who's financially responsible could benefit. "Don't use [a reverse mortgage] because you want a bunch of money to buy a boat," Pfau said. "If someone can't deal with having the cash, they might be better having their home equity tied up and not available."

A reverse mortgage needs to be a family discussion. "Make sure the children understand," McClanahan said. "We have a huge problem, in that people don't talk over their finances with their children until they are in trouble."

Some families might be able to avoid actually using a reverse mortgage. A client of McClanahan's created his own version, in which he paid his father to help with his living expenses. The son inherited the house when the father died.

Since 2015, people who want a reverse mortgage must undergo a financial assessment to demonstrate they can maintain the home and keep up with property taxes and other costs associated with ownership.

You generally have up to a year after moving out to either sell or come up with the repayment, Pfau says. The category of non-borrowing spouse, created in 2015, means the remaining spouse can remain in the house.

The home must be your primary residence, and you can't be delinquent on any federal debt.

You have to participate in counseling with a HUD-approved counselor who specializes in home equity conversion mortgages. Counseling is a good idea, McClanahan says. "When people are doing these reverse mortgages they need the money so much they discount the bad things that could happen," she said.

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