Troubled Times: Reverse Mortgages Might Be The Answer
Some important statistics for those already retired or those putting off retirement until they feel as though they've filled the retirement bucket. The news isn't good. According to some reports, almost 2 trillion dollars of retirement value has disappeared in the past year while the global economy sorts itself out. Even big name investors are losing money in stocks. If the pros are taking hits this size, what about the guy that managed his or her own portfolio or worked with the guy from the little investment boutique down on the corner? Imagine how someone in the 1970's was to be able to appropriately plan for their retirement using the old fashioned investing methods before the internet came to be.
From January 1973 to January 1975, the stock market tumbled about 50%. How long did it take for that 50% drop to recover, it really depends on whether the investor left it alone and how they made adjustments to their income and spending. Back then, the investor actually read the whole Annual report and followed profit and loss statements and their future probably contained a pension to supplement their retirement income. That's not how it works today in most cases and who has 10 years to wait until the projected growth returns to your portfolio, especially if you are drawing from it to feed yourself? "If you need to use some of the same money that you need to grow to pay for the rest of your life, you've got a problem", says Paul Arnold, managing director of the Unified Cos, a Cincinnati based financial services group. He goes on to say, "one bad year really could ruin a lifetime of planning".
As mentioned in the first article of the Reverse Mortgage Beginner's Guide, one of the most effective and efficient ways to supplement retirement income in a down market is through the use of a reverse mortgage if the investor has established a large portion of equity in their home. A Connecticut couple didn't want to move or liquidate their retirement investments; their children own their homes and supported their reverse mortgage plan. This is but one story of many where a reverse mortgage is put in place to provide the income that is missing from a person's retirement plans, but why is it not being mentioned more? Let's look into the pluses and minuses of how a reverse mortgage can help you gain access to much needed cash in a down market.
Reverse Mortgages (PLUSES)
- First of all, you retain complete ownership of your home, you remain on title until you die or sell the home.
- Any cash you take from your home's equity is tax free, it is not taxable income.
- You can do (almost) anything you want with the money, you don't have to qualify based on what you will do with your money and you can take the money in many flavors: credit line, tenure payment, lump sum, term payment or any variation.
- You don't need credit or income to qualify, you just have to be 62 or older and have a large portion of equity in your home (at least 40% or more).
- Regardless of your home's value at the time of your closing of the reverse mortgage you are guaranteed the net principle limit of your reverse mortgage transaction. If the home value decreases or stays the same for an extended period of time, if you had access to $200,000 at the time your loan closed, for example, you will get access to that amount and more (explained below in the credit line growth mechanism).
- You can take the money in many ways and you can change your mind at any time if you want to have your distribution method changed. If you decided to take the lifetime monthly tenure payment and find that you need to secure a small lump sum to pay to replace your roof (as long as that amount is available) you can make that change for a nominal fee of around $25. Your lender will recalculate your distribution into whatever method you wish after this.
- One of the methods of gaining access to your cash and also a way to grow your equity is through the credit line growth capability with your reverse mortgage. Any money that is put into the credit line grows over time, again, regardless of your home gaining or losing value during that time. The first part of the Reverse Mortgage Beginner's Guide talked about the Initial Rate or the rate at which interest accrues on the balance of your reverse mortgage loan. That same rate is also the rate that any unused equity access grows over time.
- Say a 70 year old borrower has access to $170,000 on his $400,000 home after he paid off his $70,000 mortgage using a reverse mortgage (it isn't uncommon for retired folks to still be making payments on an existing mortgage). He doesn't necessarily need additional income at that point; he just wanted to get rid of a $400 a month mortgage payment and that makes all the difference in the world to him as that $400 a month adds up to $4800 a year. His remaining $170,000 begins to grow in value over time at the current rate of around 3.94% and will be worth $209,000 in 5 years (a $35,000 increase) if the rate holds steady at a very low rate. If that rate increases, his growth will increase. A 15 year average of the initial rate plus margin for the CMT or Constant Mature Treasury rate is just over 6.05%. Imagine 6.05% growth on your equity access? Where can you guarantee any type of growth in this marketplace? A reverse mortgage can provide that.
- In the scenario above the borrower is adding an additional $400 a month in positive cash flow and could also be accessing the growth from this credit line example and keep the original principle of $170,000 intact by taking a 1/12 of the annual growth. In this case, his growth is around $7000 a year or $583 a month for a total of $983 a month of tax free cash flow using an almost historically low growth rate. Should that growth rate increase, he will be able to take advantage of that additional growth as well. That's almost $1000 a month in increased cash flow AND the borrower is protecting $170,000 in accessible cash for a rainy day regardless of his home's increase or decrease in value. That $170,000 could be used to pay taxes, be a down payment on a retirement home, pay for income health care, continue his long term care insurance, help a grandchild afford college tuition, etc. This changed a person's life just by ridding himself of the $400 a month mortgage payment and we never touched or affected his retirement account that has taken a big hit over the past 12 months and was responsible for helping him make that mortgage payment from time to time when supplies were short.
- Some positives that folks don't consider to be positives but should be brought to light; the fees that are paid to put this into place, because without some of these fees, this wouldn't be possible. A pressured retirement portfolio would be helpless without the ability for the homeowner to supplement his income with a reverse mortgage and the reverse mortgage isn't available without some fees involved.
- Another positive is that the borrower gets to keep the house instead of having to move away or with the kids or into a place they have no interest in moving. AARP has released some recent studies where almost 90% of the respondents have declared they wish to remain in their homes for as long as possible.
NOW the Negatives about Reverse Mortgages
- This is not a short term loan. If someone is planning to move in less than 2 years, there may be more affordable short term options such as a Home Equity Line of Credit (HELOC) or maybe a small private loan from a friend or family member that will be paid back upon the sale of the home in the short term. Unless a person has an immediate need to pay off bills that require immediate attention and have no other option, such as a terminally ill patient that wants to go home until they pass and they've accumulated significant bills that they don't want to burden their caregivers with, the reverse probably should not be their first option.
- There may be circumstances where the children or the estate is depending on a certain amount of equity remaining in the home for special needs services after a parent caregiver passes away, for example. If that amount can't be guaranteed at the end of the term to support that special needs child or spouse, then a reverse mortgage is probably not an option.
- If a borrower is on the young side of the spectrum, say just turned 62 and they have a large existing mortgage they want to pay off with a reverse mortgage and are not currently working to supplement future income capabilities, this may not be the best option. The equity will more quickly be eaten up using a reverse mortgage and there may be little equity left to grow in the credit line for future income reserves. This may be a situation where selling the home and moving to a more affordable scenario is the better option, especially in situations where the client has only social security to depend upon. The suggestion here would be to put off retirement until a larger nest egg is established or until a significant dent can be made in the unpaid mortgage balance. There are positives to this as well since folks tend to live longer that are active and more engaged such as what the workplace would provide, but a reverse mortgage at the youngest age in this case would be a last resort.
- If a borrower and the spouse are several years apart and the youngest isn't yet 62, be careful before considering a reverse mortgage. A 70 year old married to a 58 year old sounds odd but it may be more common that not. In this case, the 2 borrowers would not qualify because the younger is not yet 62. Some folks have taken the younger borrower off title and obtained the reverse mortgage using the older person's age to qualify for more money but if the older spouse were to die before the younger spouse qualified, they would risk losing the home if the younger spouse could not find a way to pay off the accrued loan balance the older spouse accumulated. The couple would want to see their attorney about this scenario and in some cases; the borrowers took out a life insurance policy on the older spouse that would be able to pay back the accrued balance upon their death. Otherwise, the spouse would lose the home to a forced sale, but of course they would receive any remaining equity.
We will continue to bring more examples and facts pertaining to reverse mortgages in the coming articles. Reverse mortgages are great cash flow tools for those seeking to alleviate the pressure on their retirement portfolios after the past 12 months of economic blood letting. For more information, send us an email at our contact page and a very knowledgeable resource will get right back to you with an answer.
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