You see it all the time – articles about reverse mortgages that begin with “They are not for everyone”, and then the author describes an ideal scenario. Sadly, many perfect candidates won’t consider a reverse mortgage because misinformed authors and consumer advocates have painted the wrong picture of the product.
Some phrases that are inaccurately used to describe the model applicant include:
- Older homeowner
- Cash-strapped or desperate
- Last resort
- House rich – cash poor
These are descriptions of traditional “needs-based” reverse mortgage borrowers. However, with the regulatory reforms of the last four years, these borrowers are now a smaller portion of the three primary uses described in my book.Of course, with any reverse mortgage applicant, we want to make sure it is their intention to remain in their home – preferably through retirement. But it may surprise you that the following may be qualities of an ideal reverse mortgage candidate today:
- Age 62
- Still working
- Has about 5 years to pay on their forward mortgage
- May never need to access the funds
Let’s look at each characteristic and why the product may be advantageous to them:
62 is the earliest age a homeowner can obtain a reverse mortgage. Obtaining one early maximizes the line-of-credit (LOC) growth potential of the product. Telling someone to wait to get a reverse mortgage is like telling a 35-year-old to postpone saving for retirement. This is because the available funds in the guaranteed line-of-credit will experience compounded growth. These funds are expected to grow at approximately 6.25% annually, but compound monthly. At that rate, a $200,000 line of credit would grow to nearly $700,000 in 20 years, regardless of the home’s value. This LOC grows tax free, and may be drawn tax free, which unlocks many strategic options at age 82.
Many will claim the greatest advantage of a reverse mortgage is that “there are no required monthly principal or interest payments.” I would counter with, “for those that are still working, the ability to make optional payments is a greater advantage.” For those that can make payments, a reverse mortgage loan balance will drop in a similar way as a forward mortgage. However, each payment also boosts the LOC for future use.
Many pre-retirees are faced with a decision – should I accelerate payments on my forward mortgage to reduce my loan balance before retirement OR should I save additional funds for retirement cash flow. Making payments with a reverse mortgage accomplishes both objectives at the same time.
Has about 5 years to pay on their forward mortgage
Those that only have a handful of years to pay on their traditional mortgage or Home Equity Line of Credit (HELOC) naturally have low payoff amounts. If the lender can payoff those balances and closing costs, and use 60% or less of the borrower’s initial benefit amount, the initial insurance premium drops from 2.5% (generally of the property value) to 0.5%. This is an extremely low initial fee for any government-insured loan product.
For those that are carrying a moderate loan balance on their reverse mortgage, the interest rates are still expected to be relatively low for the next few years. Ideally, the borrower would make payments during the first few years to reduce the loan balance. After that, the homeowner will benefit from higher interest rates, as the available LOC will grow faster.
May never need to access the funds
The LOC works very well as an emergency fund, a “stand-by”, or even an insurance policy. There are initial costs. But the on-going costs of the loan are based on the funds that are borrowed. In other words, if the borrower never needs the funds, the carrying costs of the growing LOC may be very low.
Imagine having a loan balance of $1,000, and a LOC of $200,000. The loan balance is expected to grow only $65 in the first year. However, the homeowner can raise their deductibles on every insurance policy they hold. They can now self-insure. This reduces expenses and raises monthly cash flow. In addition, the homeowner can draw less in taxable monthly retirement income.
Of course, this is only a partial list. We haven’t begun to discuss the many financial planning implications. For example, those who do not qualify for, or cannot afford, long-term care insurance are great candidates as the home can fund future in-home care. Those that wish to relocate, upsize, or downsize, can keep more of the gains they receive from the sale of their existing home by using a HECM for Purchase.
Years ago, I wrote that when I turn 62, I WANT a reverse mortgage. Do I plan to be a cash-strapped, house rich – cash poor, desperate older homeowner? Of course not. The financial planning advantages are too strong to ignore when the benefits are properly understood.
For more information on strategic uses of the reverse mortgage product, please purchase Understanding Reverse – 2017 and subscribe to this blog.