Although many Americans spend decades planning for retirement, the topic is often a source of anxiety. A study by the National Institute on Retirement Security reports that 56% of Americans are concerned about achieving a financially secure retirement, meaning they’re not sure they can afford it. A majority worry about running out of money.
The good news is that many retirees have an asset they may not realize can supplement their retirement income or provide needed liquidity: their home. A reverse mortgage can reduce monthly expenses and generate an income in one fell swoop. For people in the right circumstances, a reverse mortgage can be a good idea, offering access to cash flow that would otherwise be locked in their home.
When Might a Reverse Mortgage Make Sense?
Generally, a reverse mortgage can make sense when a homeowner wants to delay tapping into tax-advantaged funds such as retirement accounts to cover necessary expenses. A reverse mortgage has several advantages that can improve a retiree’s financial situation, including:
Reduce Monthly Expenses
Homeowners over 62 may qualify for a reverse mortgage, removing mortgage payments from their monthly budget. Eliminating that monthly mortgage payment can positively impact a retiree’s financial situation by reducing the amount of cash outflow and freeing up those funds for other things. That can reduce the need to draw down other retirement accounts, which can extend their useful life.
That said, it’s important to understand a reverse mortgage does not eliminate home-related expenses, and borrowers are still obligated to pay property taxes, homeowner’s insurance, and any monthly dues associated with the home. They are also required to maintain the property.
A second instance when a reverse mortgage could make sense is when a retiree wants to use the funds currently tied up in their home. Serving as a line of credit, the borrower can use a reverse mortgage to pay current expenses or create a pool of money available for the future. Because a reverse mortgage is a type of loan, any proceeds are income tax-free.
Delay Receipt of Social Security Benefits
Relying on the proceeds of a reverse mortgage to pay expenses can also allow retirees to wait to start receiving social security benefits. The longer Americans wait to receive social security, the larger those monthly payments will be. Although payments can be received starting at age 62, they can be as much as 30% lower than if the recipient waits until their full retirement age. Income from a reverse mortgage can allow retirees to wait to receive those benefits. A financial professional can help you decide if this strategy makes sense for you.
Make Gifts to Heirs or Fund Philanthropic Activities
Although they may not need a reverse mortgage to cover living expenses, some retirees opt to apply for one to spread their wealth during their lifetime. That is, the motivation for taking a reverse mortgage may not be self-focused. Funding college educations or buying homes for children or grandchildren may be possible through the use of home equity. Taking that approach, retirees can enjoy seeing the impact of those gifts during their lifetime.
When Is a Reverse Mortgage Not a Good Idea?
For all the situations in which reverse mortgages are a good idea, there are also situations in which they aren’t. The following are some situations in which a different financial vehicle is most likely a better option.
Existing Sufficient Assets
When evaluating a retirement plan as a whole, it’s important to look at the diversity of assets. If a retiree has enough cash flow to maintain safe asset distribution rates, meaning 4% or lower, long-term care protection, and additional cash reserves, leveraging their home equity may not be necessary.
Short Time Horizon
A reverse mortgage may also not make sense if the retiree doesn’t plan to stay in their current home long-term. In that case, a reverse mortgage would need to be repaid before a move is made, including all the associated costs. A better decision may be to move and, if needed, secure a reverse mortgage on the new home.
Ultimately, a reverse mortgage is likely most beneficial for a retiree whose home represents most of their net worth. Securing a reverse mortgage allows them to convert an illiquid asset into cash, to be used however they choose. With all major financial decisions, a qualified financial planner can help you weigh and understand your options.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.