Reverse Mortgages Can Help House-Rich Seniors Free Up Cash for Retirement. Here’s How They Work.

This article by Neal Templin appeared in Barron’s Dec 14, 2019.

Looking to free up $4 million to fund your retirement or pay off your mortgage?
If you’re a senior with serious digs in places like California or the New York City area or other markets where many homeowners are house-rich and cash-poor, you might be able to secure such funds with only your home. The market for jumbo reverse mortgages has come back to life.

Reverse mortgages, in which retirees tap the equity in their homes through mortgages that don’t have to be paid as long as they live there, were long regarded as a last resort. Then financial experts began publishing research several years ago showing that the strategic use of reverse mortgages could help retirement portfolios better survive down markets or delay the claiming of Social Security benefits.

Barry Sacks, a retired pension attorney who has published research on reverse mortgages, says retirees should follow a simple formula: If the market goes up, use the retirement account for income; if the market goes down, use the reverse mortgage.

Reverse mortgages looked on their way to becoming a mainstream product after that initial wave of research. But the federal government in 2017 raised the initial mortgage-insurance premiums and lowered the lending limits for federally insured reverse mortgages, shaking up the market again.

Now, lenders have been rolling out proprietary jumbo loans that aren’t subject to the new federal rules. They’ve become popular in places with high housing values where retirees can be sitting on a mountain of equity and still be short of income. For the moment, most jumbo reverse mortgages involve lump sums. But lenders are beginning to introduce jumbo mortgages that include a line of credit in addition to a lump sum.

Seniors are using the jumbo mortgages to pay off conventional mortgages or to extract money for long-term care or living expenses. Steve Resch, vice president of retirement strategies with Finance of America Reverse, said his company is doing lots of jumbo reverse mortgages for baby boomers, who are more comfortable with debt than the generation before them.

Other seniors, despite the premium increase, should still use federally insured reverse mortgages with a line of credit to stretch out their retirement accounts, says Wade Pfau, a retirement researcher who wrote a book on reverse mortgages.

Pfau reran his computer simulations after the 2017 premium increase to see if his strategy still worked in down markets. It did. “I still found value with reverse mortgages—maybe not as big as before the rule change,” he says.

How Reverse Mortgages Work

The loans allow people 62 and older to borrow against the equity in their homes. The older they are, the more money they are allowed to borrow. After a recent update, federally insured reverse mortgages will now be capped at $765,600 beginning Jan. 1.
The loan is typically repaid when they die or sell the home. As long as borrowers continue to pay property taxes and home insurance, they are allowed to remain in their houses for the rest of their lives without making mortgage payments. The loan can’t be recalled by the bank, a big reason reverse mortgages carry higher fees than traditional mortgages.

Typically, seniors have waited until they are running out of money before getting a reverse mortgage.

But Pfau and some other researchers say this is the wrong way to use them. They say borrowers should take out reverse mortgages early in their retirement and use them to protect their retirement portfolio during market downturns.

A rule of thumb for retirees has long been they can withdraw 4% of their money each year out of retirement portfolios without running out of money. But some experts think the combination of low interest rates and frothy stock markets may mean the real number today is closer to 3%.

A reverse mortgage can allow retirees to take more aggressive draws. This is particularly true for people where the equity in their home dwarfs the size of the retirement accounts, says Sacks, the retired pension attorney. Such people can safely take draws as high as 6% or 7% each year, he calculates.

Cost Considerations

For several years before 2017, the Federal Housing Administration required that borrowers pay as little as a 0.5% mortgage insurance premium on the value of their house when taking out a reverse mortgage. Some lenders were absorbing this and other initial fees so that borrowers could take out loans with almost no money down. The government was running up losses buying back the loans that got in trouble.

“It was not a good situation,” says Shelley Giordano, who founded the University of Illinois’s Academy for Home Equity in Financial Planning.

So the government raised the initial mortgage insurance premium to 2% while lowering the amount of money consumers could borrow, among other changes.

The higher up-front fees hurt the market for federally insured reverse mortgages. But they helped revive the market for proprietary reverse mortgages, which had dried up after the housing crash a decade ago.

Mary Jo Lafaye is a mortgage originator with a Mutual of Omaha subsidiary in California’s Marin County, where the median home price is over $1.1 million. She writes reverse mortgages in which borrowers extract up to $4 million in equity.

While the most common use of these reverse mortgages is paying off traditional mortgages, Lafaye is also seeing a growing number of seniors use them to pay for long-term care.

She originated a loan recently for an 82-year-old man living in a $2 million house in San Bruno, Calif., whose wife had Alzheimer’s. He had placed her in a care facility costing $8,000 a month and was burning through his retirement savings. He was still making monthly payments on a $350,000 traditional mortgage.

He got a $1 million reverse mortgage. That included $350,000 to pay off his traditional mortgage, $150,000 in cash plus a $500,000 line of credit to pay for his wife’s care.

Lafaye calculates the house’s appreciation will more than offset the amount being paid in interest each year. In other words, his estate will still have substantial value for his daughter if the California property market keeps appreciating. And if the market crashes and doesn’t bounce back, his loan won’t be affected though his daughter will inherit less money. He has a variable-rate mortgage that currently carries a 5.68% interest rate.

Three years ago, Bill Hayes, a financial planner in Plymouth, Mass., said he was asked by his pastor to help out a widow who was getting squeezed by medical bills plus taxes and maintenance on her home.

He helped her get a $100,000 reverse mortgage line of credit that allowed her to pay off her bills, while giving her additional income. “She was able to live the rest of her life in the home, maintaining her lifestyle,” he said. The widow died last year, and her daughter ended up buying the property.

Without the reverse mortgage, Hayes said the widow would have been forced to sell the property years before her death. “She had no other way to continue to maintain her home,” he said. “She had literally no money.”

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