Reverse mortgages: No longer a last resort?

HomeMany financial planners view reverse mortgages as a last resort—expensive and unwise except for those who have no other options.

Recent research and changes in the federal reverse mortgage program are starting to change those views, planner Michael Kitces told a group at the AICPA Advanced Financial Planning Conference in Las Vegas last week.

It turns out that reverse mortgages don’t work that well as a last resort. They’re often much better employed earlier in a client’s financial life. And even people who don’t need to supplement their income by tapping their home equity might want to consider setting up a reverse mortgage line of credit.

This thinking is so at odds with what had been conventional wisdom that I’m glad Kitces was the one leading this particular seminar. Kitces is a bright light of the financial planning community, one whose research and scholarship have changed others’ thinking about complex financial topics. (He blogs at Nerd’s Eye View, in case you want to check out his posts for planners.)

Reverse mortgages allow people to tap some of the equity in their homes without having to repay the loan until they leave those homes—either by selling, moving out (such as into a nursing home) or dying.

Payouts can take three forms: a lump sum, a stream of monthly payments that can last a lifetime, or a line of credit borrowers can tap when they want. The lump sum option can come with a fixed rate; otherwise, the loans are variable. Interest charged on the amount borrowed means the debt grows over time—but again, no payments are due until the borrower leaves the house.

Borrowers typically can tap 40% to 60% of their home’s value up to a cap in value of $625,500.

Although people can apply for such loans as early as age 62, planners traditionally warned people to put it off as long as possible. The concern was that borrowers would run through their home equity quickly and then face years or even decades with no other resources.

But research found that people who delayed often couldn’t get enough out of reverse mortgages to help their situations, Kitces said. People who applied earlier, and used the loans to take pressure off their portfolios, did better.

Having the reverse mortgage allowed them to pull less out of their savings, increasing the odds their savings would last, research found. Borrowers could take a strategic approach using a line of credit: tapping it during bad markets, to allow their investments time to recover, and paying back the line during good times.

Reverse mortgage lines of credit have another interesting feature: the amount you can borrow grows over time. Borrowers who apply for a credit line early and leave it untouched could wind up being able to tap 80% or more of their home equity.

The Wall Street Journal summarizes the new thinking in this post. You can read some of the research published in the Journal of Financial Planning here and here.





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Who should save 10%

Dear Liz: I often hear financial planners say you should save 10% of your income, but they don’t go into exactly what that means. Is that 10% separate from retirement or including retirement? Does that include saving for your emergency fund? Is this just archaic advice now? I’m 46 with only $40,000 saved for retirement so I’m in the panic mode that I will never be able to save enough for retirement.

Answer: Saving 10% for retirement is often considered a minimum for those who start saving in their 20s. The older you are when you begin, the more you’d need to save to match the nest egg you would have accumulated with an earlier start. That means saving 15% to 20% if you start in your 30s, 25% to 30% if you start in your 40s, and 40% of your income, or more, if you don’t start until your 50s.

Clearly, the wind is at your back when you start saving young. It starts blowing pretty hard in your face if you wait.

If you can’t carve out a huge chunk of your income for retirement, though, you shouldn’t despair. Save what you can, as anything you put aside will help supplement your Social Security checks. You may find that your expenses drop substantially in retirement, particularly if you have a mortgage paid off by then, so you won’t need to replace as much income as you think.

Another technique for coping with a late start is to work longer. That gives you longer to save, but it also allows your savings — and your Social Security benefits — more time to grow. You will be able to claim early Social Security benefits at 62, but you’ll be locking in a smaller check for life. It’s usually better to wait until your full retirement age, which will be 67, to begin benefits, since each year you wait adds nearly 7% to your check. If you wait three more years, until age 70, your check would grow by 8% each year. That’s a guaranteed return unavailable anywhere else.

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