Don’t Disregard The Value Of Your Home

14677110_sI find that when people evaluate their assets as they move toward retirement, they usually focus only on their traditional investments, things such as 401(k)s, IRAs, mutual funds, stocks and bonds. When looking for a stream of income, Social Security and pensions are examined and calculated. For good reason, these assets and sources of income are at the forefront of the retirement conversation, but there is one other, often overlooked asset, that can play an important part in retirement planning: home equity. More and more financial advisors and economic researchers are considering home equity among the list of assets that is worth talking about. Why? Because under certain circumstances, the equity in a home can be converted to cash through the use of a reverse mortgage.
For years, the reverse mortgage has been considered the ugly stepsister of more traditional retirement strategies. Many thought it was only used as a last-ditch effort by people who failed to save enough or plan well enough for retirement. But, in a time when market returns are flat or down and Social Security is continually disappointing seniors with no Cost of Living Adjustment, retirees are looking to stretch their money more than ever before. Borrowing against home equity may be an option to augment income for some retirees.
But before we talk about how a reverse mortgage can be used as part of a retirement strategy, let me explain what one is. A reverse mortgage, or Home Equity Conversion Mortgage (HECM), is a loan that allows a homeowner to convert part of the equity in his or her house into cash. The amount of equity that a person can borrow against, among other things, depends on the value of the house and the homeowner’s age. The “reverse” part of the reverse mortgage name lies in the fact that unlike a traditional mortgage where the homeowner makes payments to the lender, with a reverse mortgage, the homeowner actually receives money from the lender. The money received, and the interest on it, increases the balance of the loan each month. As this loan balance increases, the homeowner has less and less equity in the home, which is effectively the main cost of this reverse mortgage strategy. Generally, reverse mortgage loans must be completely paid off when the last surviving borrower dies, sells the home, or permanently moves out.
Not everyone can qualify for a reverse mortgage. First, in order to borrow against your house, you obviously must have equity in it. Also, the home that you are borrowing against must be your primary residence, so you cannot borrow against a property that someone else is living in, or a vacation home. There is also an age requirement, that you must be at least 62 years old to qualify.
As with any retirement strategy, it is important to consider all of the pros and cons of a reverse mortgage. Just as with traditional mortgages, in addition to the normal interest cost, there are closing costs associated with reverse mortgages. It is important to understand what these are and how they are paid before entering in to any mortgage contract.
Additionally, as with any sound retirement system, it is imperative to consider any tax impact associated with a strategy. And incorporating a reverse mortgage into that system is no different. The good news is that the distributions received from a reverse mortgage are not taxable. Instead, they are considered a loan receipt. This can be helpful if you are trying to keep your retirement income within a certain tax bracket.
I reached out to Mike Burton, owner of Slade Mortgage, for his input. Mike is a trusted mortgage professional and an expert in reverse mortgages. Mike explained that, in short, a reverse mortgage allows you to take the value of your home equity, and convert it into usable cash as a line of credit, a lump sum, monthly payouts, or any combination of the three, depending on what fits best within your strategy. He said that a reverse mortgage can make sense if you plan to stay in your house, if you can afford the cost of maintaining your home and you have enough equity in it, (usually about 40 percent). It can be an effective way to supplement your income or have money available for a rainy day.
On the other hand, Mike explained that a reverse mortgage would not be appropriate if you cannot afford the other home ownership costs, such as property taxes, homeowner’s insurance, and normal maintenance. It may also not be appropriate if your top priority is to leave your home to your kids, unless they will have the funds to pay off the loan at your death, either from their own wealth, from other assets you may be leaving them, or by obtaining a mortgage in their own name and using the proceeds to pay off the reverse mortgage.
Great input, Mike!
Look, reverse mortgages can be used to supplement income during retirement. For some, this income is used to pay for the expenses of day-to-day living. But for others, it can be used as part of a broader strategy meant to leverage what is often a person’s largest asset.
As always, there is no strategy that works for everyone. But it is important to be aware of your options and know the questions to ask so you can make sound financial decisions. And remember, do not ignore the equity in your home altogether; it may play a significant role in your retirement strategy.
Be vigilant, and stay alert, because you deserve more.