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Home Rich Cash Poor

Mike Drak

ACCORDING TO MY local newspaper, the average home price in my town rose 450% over the past 25 years. That made me ponder how I could use my home equity to fund my desired retirement lifestyle. I’m certainly not alone in thinking this way.

There are three ways you can access home equity. You can sell your home and downsize, you can take out a home equity line of credit or you can take out a reverse mortgage.

The first option isn’t attractive to many retirees. These folks want to maintain their current lifestyle, and remaining in their home can be a big part of that. The stories of COVID-19 outbreaks in nursing and retirement homes only reinforce the desire to stay put. Meanwhile, with a home equity line of credit, you’ll be compelled to make repayments during your lifetime.

What about the third option? I find reverse mortgages quite attractive. They allow you to unlock the equity you’ve accumulated in your home while still living there. That sounds great. Why be house rich and cash poor when you don’t have to be? Yes, reverse mortgages come with steep upfront and ongoing costs. Still, they can play an important role in a retirement income strategy, offering the following features:

  • They give you the choice to receive your home equity as a lump sum, as annuity payments or as a line of credit.
  • There are usually no repayments required until the home is sold—typically after your death.
  • They’re nonrecourse loans. That means that neither you nor your estate will ever owe more than the property’s market value, even if the sum borrowed plus accrued interest is greater.

There are other reasons I like reverse mortgages. For example, they can significantly increase your liquidity in retirement. You can use the extra cash they provide to fund your adventures, make large purchases, give money to family or make home improvements. All the while, you retain possession of a valuable, appreciating asset.

A reverse mortgage can also help you manage sequence-of-return risk by serving as a source of funds during market corrections. When the market drops, you can live off your reverse mortgage instead of selling investments.

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In addition, a reverse mortgage can provide income that allows you to defer Social Security retirement benefits. Those benefits increase by roughly 8% for each year you delay claiming. This increased payout continues for life and rises every year with inflation.

With so many benefits, I’m surprised more folks don’t take advantage of reverse mortgages. I believe it’s because there’s an unfortunate stigma attached to them. Many people view a reverse mortgage as the option of last resort for impoverished retirees.

I would argue otherwise. There’s nothing wrong with spending your home’s equity to support your retirement lifestyle. Why choose to live on a tight budget when you have untapped wealth at your disposal?

Consider two couples. The first buys a home and then gradually pays off their mortgage, while the second couple rents an apartment and invests in a stock portfolio. After 30 years, the first couple owns a $1 million home outright, but has little in the way of retirement savings. Instead, the couple’s wealth is tied up in their home, and they lack the cash flow to support their desired lifestyle.

Meanwhile, the second couple has amassed a $1 million investment portfolio. In all likelihood, the second couple would feel more comfortable drawing down their portfolio than the first couple would be taking out a reverse mortgage. I worry that the stigma of a reverse mortgage would force the first couple to struggle financially for no good reason. The first couple made a smart decision by buying a home. They should feel free to make another smart move—tapping their home’s equity to support their lifestyle.

I believe another reason people don’t use reverse mortgages is they worry about robbing their children of an inheritance. Some parents feel shame at not bequeathing a substantial sum. I’m not one of them. My wife and I worked hard to give our kids a good start in life. Now that they’re well-established, I don’t believe they need a further financial boost from us. Leaving them a sizable estate is the least of my concerns.

If the goal is to live your best life in retirement, you should be willing to use all the tools at your disposal. The reverse mortgage can be an effective tool, and more people should feel comfortable using it.

Of course, taking out a reverse mortgage is a major decision. Also, the money that you unlock still needs to be managed wisely. If you burn through it too quickly, you could find yourself in a tight budget situation all over again.

Want to learn more about reverse mortgages? I highly recommend the book Reverse Mortgages by Wade Pfau.

Mike Drak is a 38-year veteran of the financial services industry. He’s the author of Retirement Heaven or Hell, published in 2021, as well as an earlier book, Victory Lap Retirement. Mike works with his wife, an investment advisor, to help clients design a fulfilling retirement. For more on Mike, head to BoomingEncore.com. Check out his earlier articles.

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Dave b
Dave b
4 months ago

Worst “advice” article I’ve ever read. Reverse mortgage for what, so you can give your house away for half it’s value or lock yourself out of your own home due to a contract term written buy a slippery lawyer?

Not to mention low-ball appraisals, “adjustments” for age, basically everything that makes whole life insurance a scam, except now you lose your home and have nothing to leave your heirs. Nice.

Last edited 4 months ago by Dave b
Jacquelyn Harper
Jacquelyn Harper
4 months ago

I would never do a reverse mortgage. After when you die or your spouse dies the house won’t be of value, the interest on such a loan incurrs a high amount and then your heirs are left with nothing. My advice sell your house and then rent put that money aside in a trust and enjoy your retirement.i have heard horror stories where elder parents took out these loans, died and their heirs older children were put through the mill with the reverse mortgage companies trying to take away these homes from loved ones. Please don’t do a reverse mortgage you will regret it.

Nick M
Nick M
5 months ago

A reverse mortgage is just a specific type of loan debt. For me, using debt to cover living expenses will always have a stigma, and being retired doesn’t change that. I would much rather adapt to my financial situation than use debt to prop up an unsustainable existence. Others have said it should be a last resort, and I agree. If choosing between affording food and getting a reverse mortgage, sure, choose the loan debt. But if choosing between living in a neighborhood where others can afford their house, and I’m just trying to keep up appearances, then I would absolutely not use loan debt.

fred wallace
fred wallace
5 months ago

Greetings HD readers,
Okay, I am very curious… what are the costs of a reverse mortgage? Have they come down? The last time I looked they were egregious. Now that current interest rates have shot up, I am only imagining they have substantially climbed. Without reading Pfau’s book can anyone given the current “Bottomline” on reverse mortgage costs? For simplicity, let’s assume someone has paid off a million dollar home and wants to borrow against it. What are the closing costs and interest rates? Are these variable (most likely) or fixed? Thank you!

Suzie
Suzie
5 months ago
Reply to  fred wallace

A number of years ago I worked at a mortgage company that specialized in reverse mortgages. I admit a lot has probably changed since, and things may vary from state to state. I don’t know. What I do remember was that closing costs seemed high. Plus you did not receive the full value of what the home was worth, percentage depending on age of the owners. Any outstanding liens had to be resolved. One case I vividly remember, a dentist who owed taxes. Money was taken of the proceeds from the reverse mortgage to pay it off.

Peter Blanchette
Peter Blanchette
5 months ago

Excellent article! One reason so few people have them is that many financial planners either have not heard of them or do not want to recommend them for reasons of the commission cost(usually around 5%). I have interviewed about a half dozen planners over the years and none of them ever mentioned the word REVERSE MORTGAGE. One added benefit….the unused credit line on a reverse mortgage earns interest. Over the last 5 years they have paid between 3 to 6 % on the unused balance(same % on the $ used as well of course).

David Powell
David Powell
5 months ago

Tapping home equity will always be the last, “airbag” step in my retirement plan. All kinds of improbable but devastating “long tail” things can happen over 40 years. More than anything else, I want my spouse and I to survive all of them while remaining independent, living the life we choose, and not losing even one night of sleep to worry about money. For us, no lifestyle change is worth risking that.

Mike Drak
Mike Drak
5 months ago
Reply to  David Powell

Like you I think about “longevity planning” and yes a lot can happen over 40 years. It helps me to sleep at night knowing that if things got rough at some point I could lean on a reverse mortgage to help manage things. I think of it in terms of “in case of fire break glass.”

Mark Schwartz
Mark Schwartz
5 months ago

You may have omitted another option and that is a refinance. I took a 15 year mortgage that was paid down to 10 years at 2.625% and refinanced to 30 years at the same rate. Took advantage of the run up in housing values and took out $200k in the refinance. Still have 50% equity left with all this done. Generally opposite of a retiree mindset at 63, but Lowered my monthly payment by $400 and paying it all back with deflated U.S. dollars into perpetuity or until i croak which ever comes first.

mytimetotravel
mytimetotravel
5 months ago

I think a reverse mortgage is just an excuse to continue living in a house that no longer fits your needs. What made sense for family with kids makes little for an older couple or single. Would you buy the house if you didn’t already own it? Consider my elder sister, living alone in a four-bedroom house into her 80s. She recently suffered a stroke, and although she is managing so far with the help of friends and “carers”, she is likely going to be forced into an unplanned move.

I realized some time back that my house is not suited to “age in place”, and I don’t particularly want to, although I have loved the house and will miss my trees. The equity in my house will cover the entry fee to a CCRC, that provides Assisted Living and Skilled Nursing on the same site as Independent Living. Should I suffer the same fate as my sister, I will already be in a place where I can get appropriate care. (Of course, you need to do careful research when choosing the CCRC.)

Last edited 5 months ago by mytimetotravel
Mike Drak
Mike Drak
5 months ago
Reply to  mytimetotravel

Every situation is different and yes some people end up with too much house. In my case I love the community we live in so the size of my house is just a small part of the big picture. It all comes down to what will make you feel good and comfortable at the end of the day. To age in place you will need to make some home improvements sooner than later and they can add up cost wise.

mytimetotravel
mytimetotravel
5 months ago
Reply to  Mike Drak

I am staying in the same community, and hope to expand my circle of friends. There are several CCRCs in my area, and more than one is putting up a new building.

Bernard Binder
Bernard Binder
5 months ago

Mike,
I don’t understand why you so readily blew off the first option, downsizing. I think that option should appeal to many people, and if applicable, may be the best choice. Six years ago, my wife and I downsized from suburban Chicago to suburban Phoenix. We went from a real estate tax of $23,000 per year on a 4300 sq ft home to a real estate tax of $4,000 per year on a 2350 sq ft home. Our home in Illinois did not appreciate much since 2007, but our home in AZ has appreciated by over 50% since purchase. I get to golf twice a week all year round instead of golfing only half of the year in Illinois! We moved into an active retirement community, and we have more friends now than when we lived in the Chicago area. Yes, it gets hot in the desert in the summer, but that is when we like to travel. For us, leaving family was not an issue since we have one daughter in Brooklyn and the other in CA. Our lifestyle has markedly improved since we downsized! Not to mention that it is nice to get rid of all that crap that accumulates in your basement!

excel lent
excel lent
5 months ago
Reply to  Bernard Binder

I just spoke with two long-term Phoenix, Arizona residents about the water shortages. Water rights must be secured in new housing developments. What is your plan should basic drinking and bathing water be reduced or even eliminated? An actual possibility if the drought and non-stop growth continues down there.

Mike Drak
Mike Drak
5 months ago
Reply to  Bernard Binder

Downsizing works for a lot of people and I’m happy to hear how it worked out so well for you. However I love the community we live in and we are close to family and friends. I could downsize to a smaller home but because of the city I live in it wouldn’t put much money in my pocket at the end of the day. I told my wife when it is my time to just bury me under the bbq.

R Quinn
R Quinn
5 months ago
Reply to  Bernard Binder

Downsizing can save money – maybe. I think what you are mostly talking about though is relocation after retirement. Big difference between Chicago and Arizona as you point out.

We downsized four years ago and moved 7/10 of a mile to a 55+ condo community. Relocation was not an option as our children and grandchildren are all within an hours drive.

We didn’t save anything on taxes and HOA fees are pretty much a wash with previous ongoing house expenses. We did gain one floor living, a pool, walking paths and new friends though.

Brent Wilson
Brent Wilson
5 months ago

I agree with the premise that wealth is wealth. Spend it from whatever sources you need as long as you do so thoughtfully.

When I retire, I plan on setting up an HECM (reverse mortgage line of credit) to have at my disposal throughout retirement, mainly to hedge against sequence of returns risk as you mention in your article. The advantage over the Home Equity is not having to make repayments until markets recover.

I think being able to draw against your home’s value throughout retirement is a valuable safety net. It can also allow you to be more aggressive with your investment portfolio asset allocation.

Mike Drak
Mike Drak
5 months ago
Reply to  Brent Wilson

I totally agree with you and possibly using your home equity as a hedge in time of need.

Kristine Hayes
Kristine Hayes
5 months ago

Thanks for writing this. I agree that a lot of people dismiss the idea of taking out a reverse mortgage too soon. They seem to have the same bad reputation that annuities do. But I also think that reputation is changing as people learn more about reverse mortgages and their potential benefits.

As you mention, Wade Pfau has written extensively about how best to utilize home equity in retirement. I also highly recommend his book for anyone wanting to learn more about reverse mortgages.

For someone in my situation (married, no children), I certainly think a reverse mortgage could be a useful source of income for me as I grow older.

Mike Drak
Mike Drak
5 months ago
Reply to  Kristine Hayes

It’s important to have an open mind when judging the best long term move for you. You need to do your home work and think things through. Wade Pfau is a great source.

Nate Allen
Nate Allen
5 months ago

From the article: “Yes, reverse mortgages come with steep upfront and ongoing costs. Still, they can play an important role in a retirement income strategy”

I feel like the (much) higher fees of a reverse mortgage vs a traditional mortgage should have been given more space than one sentence.

There are the upfront fees, including origination fees, real estate closing costs, and an initial mortgage insurance premium. There are also ongoing fees, including interest on the loan, servicing fees paid to your lender, annual mortgage insurance premium, and property charges. The fees associated with reverse mortgages are larger than those associated with traditional mortgages.

Those who want to get a reverse mortgage are required to undergo mortgage counciling to make sure this is the right decision.

In short, the (high) fees eat into the amount left. The traditional advice to use reverse mortgages only as a last resort seems prudent.

For more information, see the investopedia article and the CFPB article on reverse mortgages.

Mike Drak
Mike Drak
5 months ago
Reply to  Nate Allen

Yes the upfront fees are high but it’s wrong to compare them to the cost of a traditional mortgage because of the benefits attached to a reverse mortgage.
You need to compare the long term benefits against the upfront costs and your particular situation. Wade Pfau has some good examples in his book that you might want to take a look at.

R Quinn
R Quinn
5 months ago

I see the advantages of the reverse mortgage, thought about myself, but those words “until you leave your home” bother me. Could there be circumstances where the retiree leaves the home involuntarily and the mortgage called?

What if the house is in only one spouses name? Then, of course there is the risk you mentioned of using the money and being back where you started.

My goal is to leave our kids something to help them with their retirement, college costs … life in a different world than we grew up in. So there we disagree.

Mike Drak
Mike Drak
5 months ago
Reply to  R Quinn

There is always the chance that you could require long term care which would result in the mortgage being called. However if there was a surviving spouse they would still be able to stay in the house.
With respect to the kids some people use a reverse mortgage to help them out when they need it like during a pandemic. The problem with inheritances is that they come when people don’t need it.

R Quinn
R Quinn
5 months ago
Reply to  Mike Drak

The picture has changed for the need for an inheritance for some people. Two of my children will have their children just starting college when they are in their sixties. I was 45 when my oldest started. Many people seem to be in a squeeze when it comes to retirement and college. And, unlike me none of my children have a pension.

baldscreen
baldscreen
5 months ago

This is Chris. I don’t usually comment on the articles, but I feel you have missed an important point, which is if you take out a reverse mortgage as a couple and use the proceeds, that asset will not be available for the surviving spouse for end of life care. I understand that probably a lot of HD readers are not your typical middle class household, but in our families, the paid off home has been an asset to help pay for nursing home care for our grandmas and now my mom, who had to move to assisted living recently following a stroke. The home is the largest asset of most middle class households and if it can help pay for care so your loved one doesn’t have to go into a Medicaid nursing home, that is a good thing. We live in the Midwest, which doesn’t have the same cost of homes as the coastal cities.

parkslope
parkslope
5 months ago
Reply to  baldscreen

If a couple downsizes to a less expensive house they will also have less home equity to fund a move to a continuing care facility when the time comes. However, I can’t offhand recall anyone noting that those who downsize should set aside the proceeds left over after the purchase of the smaller house to ensure that they will be able to afford CCRC expenses in the future.

On the other hand, let’s assume a couple takes out a reverse mortgage that leaves them with the same amount of equity they would have had if they had downsized. (For argument’s sake, let’s ignore the higher expenses associated with a more expensive house.) This strategy is frequently criticized as one that will deny them the ability to afford a move to a CCRC.

Mike Drak
Mike Drak
5 months ago
Reply to  baldscreen

Personally I view part of the equity in my home as a hedge against ending up in a nursing home. The other part can be used for lifestyle enhancement if at some point I decide to go that route. I went through a situation with my mom similar to yours and there was money left over at the end of the day. I used my inheritance to pay off her grandkids student debt. I think she would have liked that.

baldscreen
baldscreen
5 months ago
Reply to  Mike Drak

I think she would have also. And I get the possibility of having funds left over. This didn’t happen with our grandmas, but so far Mom ok. I was just sharing our experience of funds not left over and the grandmas having to switch to Medicaid b/c they had less equity.

TomandDeb Leigl
TomandDeb Leigl
5 months ago
Reply to  baldscreen

baldscreen (Chris). I would appreciate it if you would, or someone would elaborate more in detail about your comment:

“which is if you take out a reverse mortgage as a couple and use the proceeds, that asset will not be available for the surviving spouse for end of life care”.

My wife and I are not currently in a position to do a reverse mortgage, but it is something I have given some thought to. I would really like to know more about the pros and cons of the reverse mortgage. We also live in the Midwest. We are in our late 60’s with some health issues; house is paid for. Passing on $ to our kids is not a priority.

Last edited 5 months ago by TomandDeb Leigl
baldscreen
baldscreen
5 months ago

Our grandmothers sold their homes when they needed care. My mom sold her home when she could no longer live alone and the money is invested and paying for her care. If she and my dad had used a reverse mortgage beforehand, she wouldn’t have had as much available, b/c she would have had to pay it back when she left the home. It is kind of a “forced savings”.

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