I recently wrote about reverse mortgages for Living on the Cheap for one reason: I was curious! How else do writers get ideas?
The problem of being house rich and cash poor can hit at any age, but it is especially painful for someone who is retired. A reverse mortgage is a fancy name for a home equity loan taken in retirement. In truth, “reverse” really shouldn’t be in the name. A reverse mortgage is a mortgage, although it has some different terms than a traditional mortgage. You borrow against your home equity in exchange for a line of credit, a stream of regular payments, or a one-time lump sum. You don’t have to pay the money back until you move out of the house, often after you die. However, the bank charges interest against your loan balance until then.
The big advantage of a reverse mortgage is that you can draw money from your home equity that you don’t have to repay while you live in the house. The big disadvantage is that the principal and interest on the loan can accumulate until there is no value left, affecting estate plans and making it difficult to downsize to another residence. On top of that, the closing costs may be high relative to the cash that you receive. The earlier in retirement that you take out the reverse mortgage, and the lower the value of the house, the more expensive a reverse mortgage is going to be.
There are other ways to unlock the value of a house in retirement. In many cases, the simplest thing to do is sell the house and move to a place that is both smaller and cheaper. Another option is to take out a regular home equity loan. If you already have a home equity line of credit in place, you can draw on that without having to pay more in closing costs. Yes, you’ll have to pay it back, but this can be a great way to tide you over during a temporary tight spot. Many home equity lines of credit require only repayment of interest, which means that the burden of the repayments may not be as bad as you might think.
One of the first things to look at is whether you are able to cover your current living expenses with your current income. If yes, then a home-equity loan may be the better way to go. If not, the reverse mortgage may be. The next consideration is how the money will be used. Is this money for a dream vacation when you turn 65? If so, the reverse mortgage is going to be way too expensive. If it’s to cover the costs of nursing care because you are 85 and ailing but want to stay in your house, then it’s a more reasonable proposition.
Another issue is whether you will be able to afford the ongoing expenses of the house. As with any mortgage, the homeowner is expected to pay insurance, maintenance and property taxes. If you can’t afford that, then a reverse mortgage is only delaying the inevitable. The house itself is a depreciating asset.
Finally, do your heirs want the house? If so, it might be better to structure a purchase agreement with them now. Sometimes, people put too much effort into a protecting an asset that their descendents are not interested in owning. (And, no matter what, a good will is far more important for family harmony than any assets that may be passed down after your death.)
I have a bias against financial products that are pushed too hard, as they are often a better deal for the bank than for the customer. In many cases, that’s the situation with a reverse mortgage, so tread carefully.
