The Ins and Outs of Reverse Mortgages
Be Sure to Run the Numbers
Reverse mortgages have been both touted as a solution for older homeowners who are struggling financially, and criticized for the fees associated with them. Both observations carry some truth, but reverse mortgages can play a role in the financial plans of seniors who are not struggling financially as well.
How it Works
A reverse mortgage allows homeowners age 62 or older to convert some of the equity in their home into cash. The payments, which typically are tax-free and unlikely to affect social security or Medicare benefits, are repaid when the last borrower deceases, or sells or leaves the home. However, because the homeowners retain title to the home, they remain responsible for taxes, upkeep and other expenses.
While reverse mortgages are one way to free up cash that otherwise would remain tied up in a home, they’re not right for everyone. This is primarily due to the fact that reverse mortgages carry origination, servicing and other fees. They may not be the best solution for homeowners who plan to remain in their home for just a few years. In this case, a home equity line of credit is a better alternative.
Why Reverse Mortgages Might Make Sense
Research suggests that reverse mortgages may make financial sense for some homeowners who are financially secure. A 2012 study in the Journal of Financial Planning examined the financial impact of three strategies an individual might use to generate their cash flow needs. They include:
- Liquidating a securities portfolio and then turning to a reverse mortgage,
- Using the proceeds from a reverse mortgage while simultaneously liquidating an investment portfolio, and
- Drawing on the reverse mortgage credit line first.
Researchers found that the second and third options can, in many cases, increase the “cash flow survival probability” over a 30-year period. The reason for this counterintuitive conclusion? The investment portfolio continues to grow while the individual is drawing down the reverse mortgage.
Another strategy that homeowners might benefit from is to utilize a reverse mortgage to delay the start of social security benefits.
What You Need to Do Next
If a reverse mortgage appeals to you, make sure you thoroughly run the numbers. Reverse mortgages are complex financial instruments. While they can be a sensible option for some homeowners, making the determination requires an honest assessment of one’s financial situation, and analyzing the pros and cons of reverse mortgages.
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