When it comes to getting your financial ducks in a row, saving for retirement is something you need to do sooner rather than later. Unfortunately, far too many Americans still aren’t as prepared for their later years as they need to be. According to the Employee Benefit Research Institute’s 2015 Retirement Confidence Survey, 28% of workers have less than $1,000 saved for retirement.
If your retirement accounts are on the skimpy side and you’re closer to 65 than 25, you might be feeling a little panicky about how you’re going to make up the difference. While you should be using the time you have left working to sock away as much cash as possible, there’s another solution for coping with a retirement shortage: a reverse mortgage.
How a reverse mortgage works
Normally when you buy a home with a mortgage, you make a payment to the lender each month until the loan is paid off. A reverse mortgage involves doing the opposite, as the name suggests.
Also known as a Home Equity Conversion Mortgage (HECM), a reverse mortgage is a way to tap your equity without having to make payments. Instead, the bank makes either a monthly or lump sum payment to you, based on how much equity you’ve built up.
You still live in the home and hold on to the title and you pay nothing against the loan. You do, however, have to keep up with your homeowner’s insurance and property taxes. Any money you get from a reverse mortgage typically isn’t taxable and you may be able to roll the closing costs into the loan so you don’t pay anything out of pocket.
Using a reverse mortgage as a back-up plan for retirement
Taking on a reverse mortgage when your retirement nest egg is smaller than you’d like it to be can be a good choice if you need to supplement your income. If you’re drawing Social Security benefits and withdrawing money from your retirement and taxable investment accounts but you still can’t make ends meet, a reverse mortgage could help you cover the gap.
Reverse mortgage funds aren’t considered earned income, which means they wouldn’t count against the Social Security earnings limit if you’re claiming those benefits before you reach full retirement age. Normally, your Social Security payout would be reduced if your earned income is above a certain dollar amount for the year.
Your Medicare benefits also wouldn’t be affected by anything you’re getting from a reverse mortgage. The rules for Medicaid are a little different since your eligibility depends on your income and assets but getting a reverse mortgage doesn’t automatically disqualify you from receiving these benefits.
If your home value goes up while you’ve got a reverse mortgage, you could refinance the loan to pull out additional equity if needed. That could be especially helpful if you see your medical expenses start to climb. Data from the Bureau of Labor Statistics shows that health care accounts for 8.8% of annual household spending among 55- to 64-year-olds but it increases to 12.2% annually at age 65. If you need more income to cover rising medical bills, a reverse mortgage could be a lifesaver.
Why seniors should approach reverse mortgages with caution
While a reverse mortgage could bail you out in retirement if you’re low on cash, it’s not risk-free. Before you commit to one of these loans, there are some drawbacks you need to consider.
First and foremost is the question of what happens to the reverse mortgage once you (and your spouse if you’re married) pass away. You don’t have to make payments on a reverse mortgage during your lifetime but after you’re gone, the burden of repaying the loan shifts to your heirs. If you pass the home on to your children, they’ll have to come up with the cash to pay the reverse mortgage off. If they can’t, then they’ll lose the home.
A similar scenario can occur if you end up having to move to a nursing or assisted living facility. Reverse mortgages are intended to be used by homeowners who are living in the home. If you vacate the home for longer than 12 months, even if it’s for health reasons, the loan balance would need to be paid in full. A long-term care insurance policy could help you avoid that scenario but these policies often come with stiff premiums.
Besides the prospect of not being able to leave the home to your children or other heirs, you also have to think about the upfront and ongoing costs. If the lender won’t let you roll closing costs or other fees into the reverse mortgage, you’ll have to come up with the cash for that, which could put a strain on your wallet.
Having a higher home value is good because it means you can borrow against more equity but there’s a downside to that. If your property value is higher, your property taxes and homeowner’s insurance may cost you more. If you’re spending a big chunk of the reverse mortgage funds on paying those bills monthly or annually, that can cut into what you have leftover to pay the rest of your expenses with.
Should you consider a reverse mortgage in retirement?
If you’re on the fence about getting a reverse mortgage, there are a couple of questions to ask yourself, starting with what your end goal is for the home. A reverse mortgage may not be the wisest choice if you’re concerned about not being able to leave something to your kids down the line.
You should also take time to see what other options are available. For example, would a regular home equity loan or line of credit be doable for your budget? If you don’t want to take on a loan, could you cut your expenses or increase your income through other means, such as selling off assets or starting a side business? Looking at the situation from every angle can steer you towards the right decision when a reverse mortgage is on the table.
Have you taken out a reverse mortgage? Are you thinking about getting one?