Friday, August 26, 2016

The HECM for Purchase Program Simplifies Home Buying for Retirees

Jim Dean is a HECM loan originator who contributed a great deal to my first two posts on reverse mortgages. I asked Jim to pen the following guest post to explain the HECM for Purchase Program. In a previous post, I recommended a brief one-page overview of HECM for Purchase at Dr. Jack Guttentag's website (link below). Jim delves much deeper into the program.

"H4P", as Jim sometimes refers to it, is a program that can help retirees solve some of the problems of buying a home by using home equity when we no longer have work income to qualify for a conventional mortgage or refinance.

Buying a house is an expensive proposition, even when interest rates, both on investments and on mortgages, are at or near to historic lows. Buyers generally have two options. If they have the liquid resources, they can pay cash for the house. But most home buyers do not have or choose not to deploy that much of their liquid resources. Instead, they leverage "other people's money" – they take out a mortgage and make monthly payments. Persons 62 years of age and older have a third option. They can purchase the home using a down payment and a HECM reverse mortgage.

Paying cash means that one foregoes the earnings that the liquid resources might otherwise have generated. Taking out a 30-year mortgage entails paying interest for the privilege of leveraging other people's money. The mandatory monthly mortgage payment also imposes a significant cash flow restraint during the lifetime of the mortgage since it is typically paid from income.

A house is not a liquid asset and its value is determined by market conditions at the time and place of sale. That value is largely out of the homeowner's control.

Determining the earnings the cash buyer might have received had she invested the cash instead of using it as a down payment is difficult, as one can only speculate what the earnings opportunities might be 10, 20 or more years from now. A very rough and conservative approximation would be the interest rate being paid on the 30 year Treasury bonds – 2.27% annually at the moment.

The interest payments on a 30-year mortgage are more easily quantified. A 30-year fixed rate mortgage at 3.5% for $240,000 (80% of the cost of a $300,000 house), if held to maturity, would entail payments totaling $387,973, of which $147,973 would be interest.

As I stated above, persons 62 years of age and older have a third option of purchasing the home using a down payment and a HECM reverse mortgage. The HECM requires a larger down payment than a regular mortgage, but the reverse mortgage does not require any payment of principal and interest while the home is the primary residence of at least one borrower. The larger down payment does result in more foregone earnings than a regular mortgage would, but less than an all-cash purchase would entail.

Interest accrues on borrowed funds but does not have to be paid until the home is no longer the primary residence of either spouse. The only required payment of the reverse mortgage is the equity upon departure from the home; hence, it need not impact cash flow during residence. Whether there is equity in the house at the ultimate sale depends on two factors: market value of the house and the mortgage balance.

If the house has appreciated in value at an average rate greater than the accruing interest and ongoing Mortgage Insurance Premium on the HECM, then the owner's equity is increasing; if not, it is decreasing. Although the market value is largely beyond the control of the homeowner (he or she can influence it somewhat by maintenance and renovations during occupancy), the ultimate debt level depends on how the borrower has managed the HECM. The FHA insurance makes the HECM a non-recourse loan, meaning that if the accrued debt exceeds the market value at the end of the loan, no other assets or persons are obligated to cover the shortfall.

The HECM for Purchase borrower has several decisions to make. The first is whether to select the fixed-rate or the adjustable-rate HECM. Reverse mortgages work differently than forward mortgages. In the forward world, a rising interest rate means a higher monthly payment obligation with an adjustable rate mortgage, but in the reverse mortgage world, higher interest rates mean a debt and unused Line of Credit that is rising more rapidly. Thus, the ending mortgage debt would be higher but the value of residual equity would still be determined by the ultimate market value of the house.

It is important that the prospective borrower understands how both the fixed-rate and the adjustable-rate HECM work.

The fixed-rate HECM is a closed-end loan, requiring disbursement of all available funds at closing. By analogy, it is similar to a home equity loan. The interest rate is fixed for the life of the loan, and will not change. Partial repayment at any time is acceptable, but would be similar to prepayment on a forward mortgage – prepayments reduce the ultimate amount of interest charged, but the funds cannot be re-drawn. Prepayments fall into a liquidity trap. In the home equity borrowing market, consumers have more often "voted with their feet" in favor of the adjustable rate HELOC.

In the present market, the fixed-rate HECM with an interest rate of 5.06% offers the borrower the largest net (after closing costs) amount. In addition, all HECMs are assessed an ongoing Mortgage Insurance Premium of 1.25% annually on the loan balance. So, the fixed-rate loan with no prepayments is negatively amortizing at an annual rate of 6.31%. If the house is located in a market that consistently sees housing appreciation greater than 6.31% per year, the homeowner's equity is increasing; otherwise, equity is decreasing.

The analog to the adjustable-rate HECM is the Home Equity Line of Credit (HELOC). Both are open-ended lines of credit, with the ability to repay the debt and later redraw the funds, thereby avoiding a liquidity trap (the HELOC only during the “Draw Period”, typically about 10 years; the HECM during the lifetime tenancy of at least one borrower).

Both fixed rate and adjustable rate HECMs charge an initial Mortgage Insurance Premium at closing. This premium is either 0.5% or 2.5% of the appraised value of the house and is distinct from the ongoing Mortgage Insurance Premium of 1.25% per year on the loan balance, which applies to all HECM loans.

The lower rate applies to draws of 60% or less of the eligible loan amount in the first year of the mortgage. Draws above 60% fall into the higher risk category and are charged the 2.5% rate. Since the only funds available on the closed-end, fixed rate HECM must be taken at closing, opting for a draw at or below the 60% threshold, while it reduces the premium by 2%, also substantially reduces the funds available to the mortgagor by 40%.

Since the balance of the funds is available on the adjustable rate HECM after a required 12-month delay, the HECM for Purchase mortgagor can reduce closing costs substantially if they so choose, albeit at the cost of increasing their down payment.

For example, a 62-year old buyer using either the fixed or the adjustable rate HECM to purchase a primary residence could borrow a maximum gross amount of $157,200 in today's interest rate environment. After financing the 2.5% premium and the various associated closing costs of the purchase, that borrower would have an approximate net amount to apply towards the $300,000 purchase price of $144,000, requiring a down payment of approximately $156,000.

The adjustable-rate borrower (but not the fixed-rate borrower) would have another option that would reduce the initial Mortgage Insurance Premium by $6000 (2% of the $300,000 value). They could opt to only borrow 60% of their eligible amount at closing, or $94,320. Then their down payment would be proportionally higher and closer to 71% of the purchase price. The remaining 40% borrowing limit of the HECM, $62,880, would go into their Line of Credit, and would be available 12 months after mortgage closing.

Finally, since the adjustable-rate HECM offers benefits from making optional payments, by enhancing liquidity through the increasing Line of Credit and by potential tax deduction of mortgage interest and mortgage insurance premiums, the borrower should consider which lender margin to request. In contrast to the refinance HECM, lender/broker credits for closing costs are not allowed on the HECM for Purchase but the lender's margin will influence how rapidly the debt and unused Line of Credit will rise. If the borrower expects to make optional payments, selecting a higher margin will maximize credit line growth and interest, thereby offering a higher itemized deduction. That deduction can be timed to coincide with periods of higher income when the deduction would be more valuable.


Dr. Jack Guttentag, the Mortgage Professor website, an overview of the  HECM for Purchase program.

Tuesday, August 23, 2016

Ten Strategies for Using a Reverse Mortgage to Help Fund Retirement

In my last post, The Mortgage is Dead; Long Live the (Reverse) Mortgage, I wrote about retirement researchers' renewed interest in an improved reverse mortgage product, the Home Equity Conversion Mortgage, or HECM. The post spawned a great conversation in the comments area that pointed out, among other things, just how complicated these products are. But, that complexity contributes to the HECM's versatility.

There is more than one way to use a HECM in retirement and there is more than one kind of HECM. HECMs can be fixed rate or variable rate and there are several ways the proceeds can be distributed. There is even a HECM program that makes it easier for seniors to buy a new home when they don't have adequate income to qualify for a conventional mortgage.

This post is a summary of strategies – not an exhaustive list, by the way – compiled from the books, research papers and blog posts referenced in the endnotes below, that retirees might use to incorporate a HECM into a retirement plan.

As I suggested in the series of posts beginning with A Model of Retirement Planning, Part 1, approaching a retirement plan from a strategic perspective has several advantages. In effect, strategic planning identifies and answers the larger problems first (What do I want to achieve? What do I want to protect? What do I want to leave to my heirs?) and only then considers the best tactics to achieve those objectives (Should I use a reverse mortgage, equities or an annuity?). Once you have identified your strategic goals, some of these HECM strategies might help you achieve them.

Refinance Strategy

Do you currently make a monthly mortgage payment to the bank and would prefer that they send you a check every month, instead? If this sounds like magic or the late-night rantings of Fred Thompson, it isn't. The difference is that a conventional mortgage is building the equity in your home while the reverse mortgage is essentially spending it. Retirees who want to pass their home without debt to heirs should go the conventional route, while those who are happier depleting some or all of the home's equity to pay bills will favor the reverse mortgage alternative.

Refinancing is probably the most common use of HECMs. A retiree can refinance an existing conventional mortgage with a HECM and exchange her monthly mortgage payments for monthly loan distribution checks to spend as she sees fit. This is a double win for a retiree who currently holds a conventional mortgage – consumption is increased by spending home equity while expenses are reduced by eliminating the conventional mortgage payments.

The downside of the reverse mortgage is that spending the equity will have an impact on heirs, though they will have the opportunity to pay off the HECM and keep the home by arranging their own mortgage if your estate cannot. This is the strategy discussed by reverse mortgage originator, Jim Dean, in the comments section following my previous post. It is also thoroughly covered in Shelley Giordano's book, What' the Deal with Reverse Mortgages? (available at Amazon, see link below).

Credit Line Growth Strategy

A unique feature of HECMs is that the line of credit automatically grows over time by roughly the loan's interest rate and it increases with the age of the younger borrower. The longer you wait to spend the proceeds after taking out the mortgage, the larger your line of credit will be when you do spend it. This feature can be used to increase borrowing by taking out the loan early in retirement and spending the money years later.

As retirement researcher, Wade Pfau points out in Incorporating Home Equity into a Retirement Income Strategy, “. . . opening the line of credit at the start of retirement and then delaying its use until the portfolio is depleted creates the most downside protection for the retirement income plan. This strategy allows the line of credit to grow longer, perhaps surpassing the home’s value before it is used, providing a bigger base to continue retirement spending after the portfolio is depleted.” This strategy can be combined with others to increase the amount that could be borrowed later in retirement, for example, to pay for long-term care.

Income Strategy of Last Resort

The most common use of home equity by retirees today is probably to support spending when resources run low at the end of retirement. This was the common wisdom prior to recent research. The new research, however, suggests that spending from the HECM early in retirement rather than as a last resort tends to lead to better outcomes. When the spending will occur later in retirement, the research suggests it’s better to lock in the HECM early and let the line of credit grow. This is especially true in today’s low-interest rate environment that will contribute to growth of the line of credit as rates rise. According to Pfau, “the strategy for using home equity as a last resort supports the smallest increase in success.”

Term and Tenure Strategy

Tenure payments are one of the options for HECMs. These are monthly payments issued to the borrower for as long as he or she lives in the home. They are similar to an annuity, except that annuities pay as long as the annuitants are still living.

Another major difference between tenure payments and an annuity is that the retiree may “leave money on the table” if she dies soon after purchasing an annuity. If that happens with a HECM, there will be no such loss because the borrower will simply have borrowed less of her home equity. With tenure payments, the borrowed amount may eventually exceed the value of the home, but the borrower will never need to repay more than the home's then-current value.

A paper by Gerald Wagner entitled, “The 6.0 Percent Rule”, explains the value of the term and tenure options of HECM loan disbursements in greater detail.

HECM for Home Purchase Strategy

After you retire, you may find it difficult to qualify for a loan no matter how high your credit score because you won't have adequate income. (Former Federal Reserve Chairman, Ben Bernanke, says he was once turned down when trying to refinance.) A HECM has less rigorous credit qualification because it is backed by the home that you already own and it might be the answer to your problem.

HECM for Home Purchase is an FHA program that allows seniors, age 62 or older, to purchase a new principal residence using loan proceeds from the reverse mortgage. The program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction and avoid double closing costs. The program was also designed “to enable senior homeowners to relocate to other geographical areas to be closer to family members or downsize to homes that meet their physical needs.”

According to Jack Guttentag, author of the Mortgage Professor's website, “Prior to the HECM for Purchase program, the senior who wanted to purchase a house but could not afford to pay all-cash had to take out a forward mortgage to buy the house, then repay it by drawing on a reverse mortgage. Because the senior had to qualify for the forward mortgage in the same way as any other home purchaser, insufficient income or poor credit could bar the way. Furthermore, the senior who did qualify had to pay settlement costs on both the forward mortgage and the HECM. The new HECM for purchase program eliminates these problems.”

The Mortgage Professor website provides a nice overview of the HECM for Purchase program (link below) and the alternatives a retiree should consider.

Emergency Backup Strategy

A HECM can be established to act as an emergency fund. As described above in the Credit Line Growth Strategy, it might be wise to secure the mortgage early in retirement to allow the credit limit to grow over time.

Long-Term Care Strategy

Some retirees who find long-term care insurance unaffordable or flawed plan to tap home equity to pay for those potential expenses. A HECM line of credit is a good way to achieve this. Again, securing the mortgage in early retirement will maximize the amount of credit available when needed.

Divorce Settlement Strategy

Divorce can have a huge impact on retirement security and the incidence of elder divorce is growing. To show the broad range of retirement strategies afforded by reverse mortgages, consider this possible strategy for providing equal housing after divorce suggested by Giordano.

“For clients who qualify, a reverse mortgage can provide two options that may restore desirable housing to both spouses. By providing financing without a monthly debt obligation, each former spouse can enjoy equal housing without necessarily requiring portfolio distributions. Retirement security is enhanced for both without downgrading the living situation for either”, says Giordano.

A HECM might allow the couple to split the equity of the existing home, which one former spouse can then own, while providing funding for the second spouse to make a down payment on another home. The second spouse might also then combine that down payment with a HECM for Purchase mortgage, enabling both former spouses to own their homes without making mortgage payments. This may be a much better solution than liquidating the original home so the assets can be evenly split.

Social Security Bridge Strategy

Retirees are repeatedly told that they can mitigate longevity risk by delaying their Social Security benefits claiming age. Most households, though, claim Social Security benefits at earlier ages, probably because they need the benefits right away. (The most popular age to claim benefits is the earliest, 62.)

HECMs should be considered as a possible source of funding to help bridge the gap while you delay those benefits. Tom Davison provides a case study of this strategy at his Tools for Retirement Planning blog (link below).

Davison's case study assumes that the retiree plans to live in the home throughout retirement, so it is worth a note of caution here. For strategies that spend from a HECM early in retirement, like this one, the borrower will need to repay the loan if she decides to change housing later in retirement. Retirees who believe they might not stay in the current home throughout retirement need to perform further analysis before deciding on the strategy.

HECM Stock Purchase Strategy

One dangerous strategy, used so often that FINRA felt the need to warn against it (see Betting the Ranch, below), involves obtaining a line of credit secured by the investor's home to buy stocks. If you must buy stocks on margin – and I generally recommend that you don't – pledge the equities as security, not your home. If the market crashes you will go broke faster, but you will lose your stocks and not your home.

(Update: I asked FINRA if their Betting the Ranch warning applied equally to HECMs and conventional mortgages and they referred me to a newer warning entitled Avoiding a Reversal of Fortune (link below) that addresses the issues specific to HECMs. Short answer: it does.)

What To Do

Given the wealth of strategies, how should you integrate a HECM into your retirement plan? Very carefully.

Most every reverse mortgage expert with whom I spoke mentioned that careful planning is needed to integrate a reverse mortgage into a retirement plan. Giordano pointed out that spending proceeds early in retirement cuts off some later options. Davison noted that just because the Social Security Bridge strategy can improve benefits doesn't mean that using the Credit Line Growth strategy and spending later in retirement won't be even better for some households, so multiple strategies should be compared.

I have a couple of concerns. First, this product is very complex. After two months of research, I have not mastered the subject. Second, as Giordano explains in her book's Chapter 13, How Do I Discuss This With My Financial Adviser?, advisers may not recommend them for various reasons even if they are in your best interests. Many advisers don’t understand them. Other advisers are not allowed by their compliance officers to offer them.

Your options are to find an adviser who does understand them and is willing to recommend them if they are the best solution for you, or to invest a lot of time understanding them yourself. Given the potential benefits, I think either path is worth the effort.

Ten strategies for using a reverse mortgage in retirement.
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The Federal Government offers two major programs to assist with funding retirement: Social Security and the Home Equity Conversion Mortgage. These are especially helpful for retirees who weren't able to accumulate large retirement accounts.

There are many ways to employ a reverse mortgage in a retirement plan. Given that so many households have most of their wealth tied up in home equity, it is becoming urgent that we find ways to spend that equity. The new and improved HECM offers several opportunities.

There are some risks, however. I'll cover those in my next post, The Risks of Reverse Mortgages.

Special thanks to Shelley Giordano, Jim Dean and Tom Davison for their help with this post!


What's the Deal with Reverse Mortgages? by Shelly Giordano, available at Amazon.

Tom Davison's Tools for Retirement Planning website extensively covers reverse mortgages.

The Home Equity Conversion Mortgages for Seniors portal at the HUD website

The Mortgage Professor website post on the HECM for Purchase program

HECM for Purchase program at the HUD website

A Model of Retirement Planning, Part 1 describes a strategic approach to retirement planning

The Mortgage is Dead; Long Live the (Reverse) Mortgage, the first post of this series on reverse mortgages

Incorporating Home Equity into a Retirement Income Strategy, research by Wade Pfau.

“The 6.0 Percent Rule.” (downloads PDF) demonstrates the value of term and tenure payments.

Betting the Ranch: Risking Your Home to Buy Securities, FINRA warning regarding investors obtaining lines of credit secured by their homes for the specific purpose of investing in securities. Replaced by HECM-specific Avoiding a Reversal of Fortune.

Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income, Sacks and Sacks (2012)

Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions, Salter, Pfeiffer, and Evensky (2012)

HECM Reverse Mortgages: Now or Last Resort?, Pfeiffer, Salter, and Evensky (2013)

AARP Reverse Mortgage Pamphlet (downloads PDF)

Why Ben Bernanke Can’t Refinance His Mortgage.

Gray divorce on the rise with longevity trend from

Reverse Mortgage Funds Social Security Delay, a case study by Tom Davison at the blog.

Friday, August 5, 2016

The Mortgage is Dead; Long Live the (Reverse) Mortgage

The word "mortgage" comes from the Latin mort, meaning death, and "gage", roughly meaning a pledge to repay.

(I use these little tidbits to rationalize my choice to take four years of Latin in high school instead of learning a language I might actually use.)

So, a mortgage is the eventual "killing" of an obligation to repay something, usually referring to a home loan. Some families work hard to pay off their mortgage before retiring. Some of them should now consider applying for a different kind, a "reverse" mortgage.

The typical American family's home equity constitutes the bulk of its retirement wealth. (Home equity is the amount of money you would have left if you sold your home and paid off all mortgages.)

The Motley Fool reported in 2015 that the median net worth for Americans aged 65-69 was about $194,226 and that roughly 77% of that wealth was tied up in home equity. Most families can't afford to ignore more than three-quarters of their wealth as a potential source of retirement funding.

Fortunately, there are ways to turn that illiquid equity into a spendable asset.

One way is to sell your home and pay off the mortgage and then reduce housing costs. This only works, of course, if you can find a significantly cheaper place to live. Reducing housing costs could be accomplished by downsizing (buying a less expensive home), renting a less expensive property, moving in with relatives, or relocating to a less expensive area. The remaining capital from the sale, minus the substantial transaction costs, can then be invested or used to purchase an annuity to generate retirement income.

Finance writers love to say that "you can’t spend pieces of your home to pay bills.” But, a second way to increase retirement cash flow and consumption from home equity, the oft-maligned reverse mortgage, enables you to spend little pieces of your home indirectly.

Borrowing a reverse mortgage isn't exactly like spending home equity directly because you will have to pay closing costs to obtain the loan and you will have to pay interest on the loan. And, of course, you or your estate will have to repay that loan.

Your choice among selling and downsizing, taking out a reverse mortgage, and leaving your home equity untouched will depend primarily on whether you:

  • Intend to sell your home at some point and live somewhere else (it may be better to sell and downsize when you're ready),
  • Want to keep your present home for the rest of your life but are not concerned about leaving an unencumbered home to your heirs (consider a reverse mortgage), or
  • Want to live in your present home for the rest of your life and then leave it unencumbered by debt to your heirs (just leave the equity untouched).
Note that you can leave the home to your heirs with the reverse mortgage option, but the loan will have to be paid from other estate resources or your heirs can arrange for a new mortgage – they can keep the home, but the reverse mortgage will have to be repaid.

Most reverse mortgages are offered through the Home Equity Conversion Mortgages (HECM) program administered by the Housing and Urban Development Department (HUD) and the Federal Housing Authority (FHA). A HECM reverse mortgage can be paid out in five different ways, according to HUD:

  • Tenure- equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence. (Like a life annuity, but ends when the home is no longer occupied as opposed to annuitants no longer living.)
  • Term- equal monthly payments for a fixed period of months.
  • Line of Credit- unscheduled payments or in installments, at times and in an amount of your choosing until the line of credit is exhausted. (Useful as an emergency fund.)
  • Modified Tenure- a combination of line of credit and Tenure.
  • Modified Term- a combination of line of credit and Term.

There are several unique advantages to a HECM reverse mortgage.

The main benefit of a HECM reverse mortgage is that it enables the retiree to spend home equity without selling or otherwise giving up title to their home.

There are no prepayment penalties. The lender charges interest but it doesn’t have to be paid until the mortgage is due. Fees, interest payments and the balance on your old mortgage can all be financed with the new loan if you are granted a large enough loan. In fact, one of the benefits of a reverse mortgage for borrowers with a relatively small balance on their original mortgage is that they will no longer have to make mortgage payments. They can begin to receive a monthly check, instead.

HECM reverse mortgages are non-recourse loans. That means the borrower will not owe more than the property's value when sold or at death. Technically, it means that the lender's only recourse for settling the loan is the home itself. A lender cannot demand repayment from your other assets.

There are downsides.

The reverse mortgage must be repaid when both spouses die or sell the home, or when both spouses move out of the home for a year or more. If you decide to sell your home or are forced by a financial setback to downsize, your mortgage will become due and payable. The non-recourse feature means the outstanding debt can’t exceed the sale proceeds from the house, but if you set up the HECM to make tenure payments, those payments will stop and you may find them difficult to replace.

Retirement researcher, Wade Pfau, notes in Incorporating Home Equity Into a Retirement Income Strategy, that high costs can be an issue. It’s worthwhile for potential borrowers to shop around. Typical closing costs, according to a number of sources including AARP, run from $2,000 to $4,000, but most costs can be financed by the loan, in other words these costs, like interest payments, can be added to the loan balance and will not be due until the loan itself is due.

The borrower is responsible for paying property taxes, insuring the home and maintaining it. Failure (or inability in a financial crisis) to do so is grounds for the lender to call the loan. Of course, that's also true of a conventional mortgage.

Some misunderstand that the borrower loses title to the home when she takes a reverse mortgage. The lender does place a lien against the property ensuring the reverse mortgage will be repaid when the home is sold, but home ownership does not change.

I have read of family issues raised by children who expected to inherit a home only to find that their parents had spent the equity and the home needed to be sold to repay the reverse mortgage, or the heirs needed to take out a new mortgage. This is more a family issue than a financial one. Having this family discussion early on should set proper expectations.

Lastly, a potential downside of HECM reverse mortgages is the maximum loan amount, currently $625,500. Retirees with more home equity than that might free up more by selling and downsizing.

Recent research has changed some opinions on reverse mortgages.

Although reverse mortgage have gotten bad press over the years, Pfau and others have a better opinion of HECMs as a result of research beginning in 2012 and program changes in 2013.  “I think it’s really important for advisors who may have done their due diligence about reverse mortgages 10 or 15 years ago to look at what all has changed starting in 2012 and to do their due diligence over,” Pfau recently stated at

Harold Evensky has said that the motivation for the reverse mortgage research at Texas Tech came about when home equity lines of credit (HELOC) kept getting canceled during the financial crisis in 2008. A HECM reverse mortgage, unlike a HELOC, is guaranteed to be available when you need it. provides a nice overview of how reverse mortgages work but a more detailed explanation can be found at Tom Davidson's Tools for Retirement Planning blog. Here's a simple example.

Let's say your home is valued at $700,000 and you owe $100,000 on your home's mortgage leaving you with $600,000 equity. You could borrow a $200,000 reverse mortgage and the lender would immediately pay off your $100,000 existing mortgage, leaving you $100,000 (less fees) to borrow. Your old mortgage payments go away.

You could annuitize the $100,000 with tenure payments, effectively replacing your monthly mortgage payments with a monthly check to spend for as long as you live in the home. You still own your home, though the lender will place a lien on the title. Your estate must repay the mortgage, but only the part that doesn’t exceed the home’s then-current market value. If the estate cannot cover the outstanding balance, your heirs may be able to arrange for a new mortgage if they want to keep the home.

Pfau also points out the advantages of applying for a reverse mortgage early in retirement and not spending the money right away. The HECM credit line grows over time. To quote Pfau from Forbes magazine, “Should the borrower live in the home long enough, the loan balance will likely grow to exceed the value of the home.”

Who might use a reverse mortgage? 

The latest research is usually adamant that reverse mortgages aren't for everyone. Every article you read about these products states that, but very few tell you who they are for:

  • You must be at least 62 years of age.
  • You will need to have paid off your mortgage, or nearly so, or have adequate additional liquid assets available to pay off existing liens since the first thing you must do with a reverse mortgage is to pay off your existing mortgage.
  • You must be willing to hold a mortgage on your home – perhaps not attractive to people who once worked hard to become mortgage-free.
  • You must be able to pay property taxes, keep up with homeowners insurance, and pay for regular maintenance on the home.
  • You should want to age in-place in your current home. You can change your mind later, but when you sell your home you will need to repay the reverse mortgage.
  • You must accept the risk that your estate won't have adequate resources to pay off the reverse mortgage without selling your home.
  • The home must be at least one spouse's principal residence.

Reverse mortgages are extremely complicated and the expenses can be substantial. If you think this might be an attractive alternative to consider, I recommend you find a good, unbiased financial planner to guide you and that you shop around for rates.

Furthermore, you need to fully understand what could happen to borrowers in the worst-case financial outcomes. A retired borrower with other financial pressures might need to sell the home earlier than planned. In that event, the HECM will become due and payable when they move out and they could see the reverse mortgage called at the worst possible time. Those lenient repayment terms might disappear when they're needed most. I'll post about that one day soon.

Lastly, some researchers have recently recommended using reverse mortgages to reduce sequence of returns risk and permit higher withdrawal rates. As I have previously hinted, I'm not on board with that concept, at least not yet. I'll post about that soon, too.

Reverse mortgages have gotten a bad rap, but recent research suggests that they are worth a second look. They're complicated, some uses are risky, and they’re not appropriate for every household. But bottom line, if a lot of your wealth is tied up in home equity, a reverse mortgage can help you increase retirement cash flow and consumption without selling your home.

You worked really hard to pay off your mortgage before you retired. Want another one?
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Wade Pfau referenced several recent papers on this topic. If you're interested in the research, check out the following:

Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income, Sacks and Sacks (2012)

HECM Reverse Mortgages: Now or Last Resort?, Pfeiffer, Salter, and Evensky (2013)

The 6% Rule, Wagner (2013)

AARP Reverse Mortgage Pamphlet (downloads PDF)