[Editor's Note: This post is part of a three-post series on reverse mortgages we are running this week here at WCI. I wrote an introductory post on Monday. This post has a bit of an optimistic tone to it and will discuss some of the ways to use a reverse mortgage you have not perhaps considered. And Friday I'll offer a few cautionary remarks. This post is written by Josh Mettle, a long-time WCI advertiser, whose firm–Neo Home Loans–not only offers doctor mortgages, but also reverse mortgages. His study of reverse mortgages was caused when his mother came to him to ask about how she should manage her retirement spending and he had to make a recommendation to her about whether a reverse mortgage was right for her. Josh is an industry leading author and mortgage lender, specializing in financing physicians, dentists, CRNA, and physician assistants. You can check out his book and podcast as well. He wishes me to remind you that he is a mortgage lender, not an attorney, accountant, or financial advisor and recommends you consult with your sources before implementing any of the ideas in this article. The post is lengthy, but give us a little credit–It was originally 5000 words. Josh cut it down to 4100 and I whittled it down even more to about 2500.]
The purpose of this article is to make you aware that there are substantial misconceptions about reverse mortgages. It was initially difficult for me, as well as other professionals, to get past the dogma and into the facts.
In fact, I had to unlearn what I thought I knew about reverse mortgages. I discovered that they are not just for the financially strapped. For many middle and upper middle income homeowners, a federally insured Home Equity Conversion Mortgage (HECM) may even be a good starting point for retirement planning, rather than an option of last resort, as it has been commonly viewed.
The FHA’s HECM reverse mortgage can offer numerous potential advantages for those 62 and older, including:
- Significantly greater tax efficiency of retirement income
- Consistent monthly payments and/or “insurance” against many financial catastrophes
Josh Mettle
- The potential to increase the value of what you leave to your heirs
- The ability to help prevent running out of money before you or your spouse pass away
Here are the 10 things I thought I knew about reverse mortgages that turned out not to be true.
# 1 Reverse Mortgages Are For Penniless Widows
Historically, a reverse mortgage has been used as a loan of last resort by people who are desperate and out of options. Ironically, this may be the group that benefits the least from a reverse mortgage.
Think about this for a moment, when you are retired, the income you draw from your retirement accounts is in most cases taxable income. The more you draw, the higher your tax bracket, which results in a greater attrition of your retirement and estate assets. Paying taxes on every dollar you draw to survive in retirement is very inefficient tax-wise.
Reducing the income you need to draw from your retirement accounts reduces your tax rate and preserves your asset base. A HECM eliminates your monthly mortgage payments for as long as you and your spouse live and remain in the home and provides you either with a steady stream of tax-free* monthly deposits into your checking account or a tax-free line of credit you can draw upon whenever you need it. You are giving up some of the equity from your home, but you are using it to preserve the rest of your assets and lowering Uncle Sam's share at the same time. You may also be able to delay taking Social Security, resulting in an increased monthly benefit.
# 2 I Don’t NEED A Reverse Mortgage
If you feel you don’t need any of the benefits that a reverse mortgage can offer now, realize that may change later due to personal or macroeconomic events causing sequence of returns risk.
“Buy low, sell high” is good advice in any stage of life. When you are retired and your resources and ability to create income are comparatively limited, that principle becomes paramount. Prudence dictates that you hedge your bets and insure yourself against an economic downturn. A reverse mortgage is a non-taxable way to do that. It provides you with another liquid asset base to draw on, especially during down periods when you want to hold on to your other assets and avoid having to liquidate them at bear market prices. A HECM can be a defacto insurance policy to help you ride out those bear markets until they return to bullish territory.
# 3 A Reverse Mortgage Is Stealing From My Children And Grandchildren
Not really. Many want to pass their home on to their children when they die. This is a noble, responsible, and admirable instinct, which I happen to share. But is it practical?
What is going to happen when we die? The truth is that in most cases the kids and grandkids will be more interested in having the cash in hand than the house. In most cases the sale of the physical home is just another problem they have to deal with. That might not be true for everyone, but it was certainly true for my family and I bet it holds true for most. If it’s true for you and your heirs as well, everyone is likely better off if you adopt a strategy that maximizes the amount of cash you can pass on to them, while preserving the home for you and your spouse to live in mortgage-free.
# 4 The Bank or Government Will Own My Home
Not true. You do not convey title to anyone else when you take out a reverse mortgage. You retain the same rights you have now. You will still be free to do whatever you want with your home, even to sell it or refinance the mortgage, you simply need to payoff whatever balance is on the reverse mortgage and the rest of the equity is yours, exactly like any other mortgage. Perhaps even better than a traditional mortgage where if something happens and you can't make payments you'll lose your home. The reverse mortgage frees you from payments and foreclosure, although you do have to pay the taxes, insure the home, maintain the property, and continue to live in it.
# 5 My Spouse Will Be Evicted When I Die
As long as both spouses are listed on the reverse loan, the remaining spouse can still live in the home, mortgage free, until he or she either passes away or moves out of the home as a primary residence. A reverse mortgage comes to maturity when the last of the qualifying owners, you or your spouse, dies or moves out of the house. At that point, you, your estate, or your heirs will decide what to do with the home. The will have up to a year after the death of the last surviving spouse to settle the terms of the reverse mortgage. If there is equity in the home, they will sell it and take the equity. If the value of the home at that point is less than the balance on the reverse mortgage, they just walk away. A reverse mortgage is a “non-recourse” loan. The lender is made whole by the insurance you paid when the loan was originated.
In fact, an upside down home is good news for your heirs. Since you spent more than the home was worth, you were able to leave them even more money than if you had left them the home!
# 6 All My Home Equity Will Go To The Bank
Your equity won’t go to the bank, it will remain yours, but in a potentially more useful form. The whole purpose of a Home Equity Conversion Mortgage (HECM) is to convert your home equity into a more efficient combination of assets. A HECM is a guaranteed for life interest in the home for you and your spouse without the burden of payments or worry of foreclosure PLUS an ever growing line of credit that you can use however you choose, whether in the form of a lump sum, monthly tax-free draws, or a revolving line of credit. The guaranteed growth of the line of credit, discussed in Monday's post, regardless of what happens to your home’s value, is where the reverse mortgage can become really advantageous.
That guaranteed growth of the line of credit is like a put option on the future value of your home. If a bear market ever causes your home to decline in value, you’ll have already guaranteed its future liquidity at a price determined by today’s value multiplied by the credit line expansion formula. Do you know of any other way to buy a put (that doesn’t expire until you die) on home liquidity? The more that home values decline during an economic downturn, the more valuable it would be for you to have a line of credit that is guaranteed to grow.
The intention of this chart is to educate consumers. Data is based off projections; the line of credit growth rate is based off the 10-year SWAP rate and age. Home price appreciated forecasts and 1 month – Libor based on Moody’s Analytics.
# 7 It Would Be Safer To Have No Mortgage On My Home
Certainly this is a sacred cow we instinctually believe, but could there be a downside? A free and clear home that provides you with no liquidity leaves you with few options in times of need. I would also consider an unencumbered asset that is easily searched on public record less than safe. In today’s lawsuit happy society, owning a home free and clear in your personal name can be a pretty big target. That’s why, when I paid off my home, the first thing my attorney told me to do was to record a lien against the property so I would appear to have little equity and be a less attractive target for litigation (thanks for the advice Mom!). Now you certainly don’t need a reverse mortgage to shield yourself from potential lawsuits. You could consult your estate attorney, transfer the property to an entity such as a trust, a limited partnership, or an LLC, all of which would afford you some degree of protection, but the point is feeling safe and being protected are not always the same thing.
This sacred cow was born out of the Great Depression, when too many people lost their homes because they couldn’t make the payments. Widespread fears of losing your home to the bank have been re-kindled by the recent Great Recession, when banks foreclosed on many thousands of homes. But keep in mind that these foreclosures were almost all associated with traditional mortgages and home equity lines of credit.
[Editor's Note: Having a mortgage on the home may or may not provide additional asset protection. Asset protection laws are state specific and some states provide excellent creditor protection for home equity while others provide little to none. Be familiar with your state's asset protection laws. In Utah, where Josh and I live, home equity receives little more protection than a taxable account.]
# 8 My Home Must Be Debt Free To Qualify For A Reverse Mortgage
Not true! Even if you are making payments on a traditional mortgage right now, you are most likely eligible for a reverse mortgage as long as you are at least 62 years old and have 50% equity or more in your home.
# 9 You Can't Buy A Home With A Reverse Mortgage
Yes you can. You could move to Arizona, put 50% down on a house, and never make another payment for the rest of your life by purchasing with a reverse mortgage.
# 10 A Reverse Mortgage Won’t Help Me Save Taxes
A reverse mortgage can help you pay less in taxes than you would otherwise. Consider a scenario in which a reverse mortgage might give you greater tax efficiency than a free and clear home. Imagine that you opened a reverse mortgage on your 62nd birthday and you no longer had to make a mortgage payment for the rest of your life. Let’s assume that your Initial Principal Limit amount was $300k and that you had a small balance remaining on your home mortgage at the time, maybe $100k or so. That left you roughly $200k to draw upon. Let’s assume you established a line of credit and made deposits from the line of credit into your checking account of about $1,500 each month. Keep in mind that you would accrue interest on these withdrawals, but as mentioned earlier, the line of credit is guaranteed to grow for life at that same rate of interest. The line of credit is ALWAYS growing.
Eight years later, you turn 70. Assuming you supplemented your income with your line of credit for the last 8 years and have not made a mortgage payment since you turned 62, you haven’t had to draw as much out of your retirement accounts. It’s likely that allowed your retirement assets to compound and grow to a much larger balance than if you were drawing living expenses and mortgage payments (and paying the taxes) to live on.
Then you turn 70½ and start taking Required Minimum Distributions (RMDs) from your retirement accounts. Distributions from tax-deferred retirement accounts generally result in taxable income. The percentage of your account that must be withdrawn depends on your age. That percentage is multiplied by the account balance at the previous year end. So the larger the IRA, the larger the distribution and the tax bill that comes with it, whether you want to spend the money or not. What else could you do with it besides spend it or reinvest it in a taxable account?
You could use it to pay down the balance on your reverse mortgage because any elective payment made on a reverse mortgage goes first toward accrued interest. This may benefit you in two ways:
- You may get a mortgage interest deduction (which may reduce the tax bill from the RMD)
- You reduce the outstanding balance, resulting in more available credit you can withdraw later.
If you accumulated $80k worth of deferred interest during the nearly 9 year period (from your 62nd birthday to sometime after age 70½) when you were drawing on your line of credit and not making mortgage payments, you could make an elective $80k payment towards that interest. This would give you an $80k 1098 mortgage tax deduction to offset some of that RMD that just kicked in.
This can give you some slick tax-planning options as well. You could get a $30K tax deduction by paying $30K in deferred interest in December and then write yourself a $30K check from the reverse mortgage in January.
There are a lot of misconceptions (bordering on ignorance) about reverse mortgages and how to use them and much of the conventional wisdom is wrong. Of course, interest and other costs associated with reverse mortgages should be considered and weighed against the tax, legacy, and financial benefits they potentially provide. We recommend clients seek the guidance of their accountant, financial advisor, and estate attorney before making any decisions regarding a reverse mortgage. Unfortunately, many of these professionals have not yet educated themselves on the subject; we have listed several published papers by industry experts below. If you are interested, I would encourage you to forward this article and the research papers listed below to your advisors for their review and comment.
- How to Manage Sequence of Returns Risk with a Reverse Mortgage
- Incorporating Home Equity Into A Retirement Income Strategy
- HECM Reverse Mortgages: Now or Last Resort?
- Increasing the Sustainable Withdrawal Rate Using The Standby Reverse Mortgage
- Reversing The Conventional Wisdom: Using Home Equity To Supplement Retirement Income
- Recovering A Lost Deduction
What do you think? Did you realize you could do all that with a reverse mortgage? Would you consider using one for yourself? What about a less well-to-do family member? Why or why not? Comment below!
*Disclaimer: Copyright © 2017 eJLM LTD. All Right Reserved. Fairway Independent Mortgage Corporation (“Fairway”) NMLS#2289. 4801 S. Biltmore Lane, Madison, WI 53718, 1-877-699-0353. All rights reserved. Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA and were not approved by HUD or a government agency. Reverse mortgage borrowers are required to obtain an eligibility certificate by receiving counseling sessions with a HUD-approved agency. Youngest borrower must be at least 62 years old. Your monthly reverse mortgage advances may affect your eligibility for some other programs. At the conclusion of the term of the reverse mortgage loan contract, some or all of the equity in the property that is the subject of the reverse mortgage no longer belongs to you and you may need to sell or transfer the property to repay the proceeds of the reverse mortgage with interest from your assets. We will charge an origination fee, a mortgage insurance premium, closing costs or servicing fees for the reverse mortgage, all or any of which we will add to the balance of the reverse mortgage loan. The balance of the reverse mortgage loan grows over time and interest will be charged on the outstanding loan balance. You retain title to the property that is the subject of the reverse mortgage until you sell or transfer the property and you are therefore responsible for paying property taxes, insurance, and maintenance. Failing to pay these amounts may cause the reverse mortgage loan to become due immediately. Interest on reverse mortgage is not deductible to your income tax return until you repay all or part of the reverse mortgage loan. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Lender. AZ #BK-0904162. Licensed by the Department of Business Oversight under the California Finance Lenders Law. Loans made or arranged pursuant to a California Finance Lenders Law License. Georgia Residential Mortgage Licensee. Georgia Mortgage Lender License #21158. Illinois Residential Mortgage Licensee. MA Mortgage Broker License #MC2289. Licensed Nevada Mortgage Lender. Licensed by the NJ Department of Banking and Insurance. Rhode Island Licensed Broker & Lender. TX Location: 1800 Golden Trail, Carrollton, TX 75010.
One consideration is the required insurance by the mortgage company. When I had a $100,000 mortgage the bank required wind and hail insurance policy @ $5200. By paying off the mortgage, I was able to drop wind and hail resulting in a policy costing $1200. So adding $4000 to the cost of a new mortgage could potentially add roughly 4% in the case of a $100,000 mortgage. Don’t know if all lenders require wind and hail, but Wells Fargo did.
Yeah, Wells Fargo requires me to maintain a $1000 deductible on my home owners policy. I would certainly opt for a higher deductible if I could. No wind or hail requirement, though.
I actually knew zero about reverse mortgages before this, so thanks for putting this together! Great read!
This is the first positive post I’ve seen on reverse mortgages – other than from people who sell them. This is good information to consider for sure. I would need to understand the fees specifically though. I’ve heard there are really high fees associated with reverse mortgages.
The author does sell reverse mortgages according to the WCI comment at the top. So the positive treatment is not too surprising. The article seems a little light on the numbers. Would still lump reverse mortgages with whole life insurance. Something to avoid as the devil is in the details.
With interest rates being so ridiculously low right now, how does a reverse mortgage compare to just taking out a new 15 yr mortgage at 3.2% or 30 year at ~4.0%? Of course, in those instances interest accrues on the entire amount from the beginning—but that’s negated by taking the mortgage tax deduction from the beginning as well (compared to taking it all later as outlined above). Also, if I was pulling out 250k in a 15 yr mortgage, I could always get ~1.1% from a high yield savings account to account for some of that interest expenses.
Lots of benefits of a HECM that you don’t get with a HELOC or a new mortgage.
Although this topic deals with something that would be years away for me, I am somewhat interested in it as a way to self-insure against running out of money later in life, especially if I am an early retiree, or to provide extra spending money in the retirement years.
My mindset moving forward is to help my kids as much as I can as they grow up by giving them a good childhood, completely funding their education, and helping them through their young adult years with houses and cars. I feel this is when they will “need” money the most. I have much less of a desire to leave behind a huge inheritance and/or house. My goal is actually to spend most of the money I make at some point in life as opposed to dying with millions. For this reason I am interested in the topic of a reverse mortgage.
Maybe I didnt read close enough, but assuming one takes out a reverse mortgage at 62 and uses this to live off of exclusively for several years (as opposed to spending down retirement accounts), would this be considered taxable income? If not, couldn’t one live off of the equity for years while making large Roth conversions from their 401k??
“If not, couldn’t one live off of the equity for years while making large Roth conversions from their 401k??”
This is exactly what popped into my mind, if one hadn’t built enough of a taxable account or other liquid funds to live off of and pay for the Roth conversion taxes.
I think that strategy could work out well. But depends on a lot, such as future rates of return and tax rates.
Not understanding how the LOC can grow beyond the value of the home.
It sounds like the PLF x $625,000 could be higher than the value of a reasonably priced home, but surely someone involved in the government MIP program would have been bright enough to place a cap after the 2008 real estate meltdown. I’m really hoping we’re not subsidizing “making the lender right” for loans that are 100%+ of the actual home value.
Could someone explain how the LOC might exceed the loan value? Thanks!
The growth of the line of credit is divorced from the rate of appreciation of the home, that’s how it could potentially grow beyond the value, the “put option” if you will.
And yes, in some respects the taxpayer could subsidize the lender in the HECM program.
I am told by a knowledgeable mortgage broker that many reverse mortgages purveyors “pad” their fees, by charging the clients significant fees, and also getting payments from the lender (by, for example, charging the client a higher margin than necessary, or having the client take a draw up front that they do not need).
How can a client ensure they are getting a fair deal on a reverse mortgage?
Phil- This is a good question, and like in any industry, there are some bad players in mortgage. The only way I know to protect yourself is to speak with several lenders, find someone that has the heart of a teacher, who is more interested in educating you than selling you. Then get a couple quotes. One more thing to mention, there is a required HUD counseling session that every reverse mortgage client must go through, this is a one on one meeting (either live in person or on the phone). The HUD counselor reviews and signs off on the reverse mortgage proposal. This is a disinterested 3rd party, who’s job it is to evaluate the loan and costs as a whole and offer advice. I would say that is another resource.
This was an informative post, albeit from someone who sells the product. I will echo some previous comments in that there are some details left out. Maybe this was already discussed but I can’t seem to find the answers (maybe they were discussed): What are the fees charged and how does the broker make their money? WCI, are you considering a reverse mortgage (since it has so many benefits)?
My thoughts on HECMs will be covered extensively on Friday, but the short answer is probably not because I’m not big on debt and even if I was, the amount I could get through a HECM wouldn’t move the needle in my financial life.
Does the income count towards the AKA act? (I have tax free accounts which is great for taxes but I have to add it back in to find out my premium deduction so I just want to know if this is going to increase my “income” regarding the AKA thereby increasing my monthly premiums).
AKA Act? Did you mean ACA?
The funds received are loans, not income. Similar to drawing funds from a HELOC.
Thanks Chris, and yes to others when I mistakenly said AKA instead of ACA.
Not sure what AKA is (ACA maybe?) but this isn’t income, it’s borrowing money so it doesn’t count against anything where your income matters. It’s like borrowing against your car or your credit card or whatever.
Is someone going to do a rebuttal post for this? This reads like a “#10 reasons why WL/UL is now good” post, which would cause 50 people to jump all over the post (and would be fun to watch)
I need to spend less time with the kids and write something good. Instead you’ll get my quick random thoughts.
#1 – How much ‘income’ is someone withdrawing? A married couple can withdraw $50+k before they hit the 25% tax bracket. And that’s before accounting for the standard deduction and personal exemption (when you add them in this easily increases to ~$70k) This assume all their money is in 401k, No Roths, no savings, no Traditional accounts to draw from. And we aren’t even factoring in things like you won’t have to pay FICA taxes (another 15.3% extra that shows $70k from a 401k withdrawal has more utility than a $70k salary)
#2 – You need a good holistic financial plan that can survive a market downturn. Not a HECM. What are you going to do when 2008-2009 comes knocking again? Stay calm and don’t panic.
#3 – If this is true then any consumption is stealing from your heirs. Vacation, cars, house, eating out (the list goes on and on) and even giving to charity.
#4 – Skipping
#5 – If you googled reverse mortgages, you would have the answer to this question pretty fast. Do we really want a situation where there are lots of people have upside down reverse mortgages? No. Think about the macro economic ramifications if a bunch of houses were under water. We just went through this less than 10 years ago. I hope I live another 60 years and never see that again.
#6 – Writing a “Put Option” on the future value of your home. Wow. Should we really be buying Put Options on our house? This is a VERY expensive Put Options, not a $7.95 one from your broker. Would you buy a Put option on a specific stock? Probably not. Why buy one on real estate you live in?
The chart is lacking details. They assume a $600k house that grows to $3.4M in 2055 (38 years from now). It’s hard to predict what $3.4M will buy you in 2055 dollars (these are 2017 dollars, these are 2055 dollars). Sure if you took the loan out at 62, died at 100, your kids could get $3.4M – “What is owed the bank”…..it seems unlikely that this scenario works out according to plan and is a benefit to you and your heirs.
#7 – Ah – Using a HECM to solve a liquidity problem. This assumes you have other substantial non-liquid assets that you can’t tap right now but will in the future. I’m guessing most people on this form shouldn’t have that problem. Those without other savings have a savings problem not a liquidity problem.
#8 & #9 – Skipping
#10 – I love the “A reverse mortgage will help you pay less in taxes” ignoring the fact that you end up paying more in interest in fees in order to get that tax deduction. Gifts to charity will help you pay less in taxes than you would otherwise.
If your 401k RMD’s are going to be large enough that you are worried about a tax problem due to the RMD, I would suggest start taking them as soon as retirement happens and your income drops in order to get as much money out in the 10%,15%,25% tax brackets and not the 28%,33%,35% as you can.
As I read the scenario where the author describes how to take advantage of a HECM and the assumptions used to make the numbers work, I think, why complicate my life? If something complicates my life, there should be a real, tangible benefit to having it in my life.
No where does he talk about fees and wading through complex terms. In theory annuities shouldn’t be horrible products, but they are due to the fees, terms and conditions applied to them. My $0.02
as WCI mentioned this is the optimistic post on this topic. I agree it’s just like a bad WL pitch. Little details, tax scare tactics, and pretending that the words tax free should be used in front of loan which they shouldn’t be since all loans are tax free.
HECM might not be a good fit for the typical WCI reader for the reasons you mentioned.
Unfortunately, the majority of non-WCI retirees don’t have a good financial plan, liquid assets or enough retirement savings. For those with a fully paid off house (which isn’t unusual after age 65), HECM is worth considering for a fixed income household that is struggling to survive on a pension and Social Security.
That sounds like point #1 to me. A nuanced scenario in favor of HECM would be the high net worth couple with no heirs.
#1 It’s not taxable income. It’s borrowed money, so tax-free but not interest free like borrowing against your car, your next paycheck, or your whole life policy.
# 5 You can’t get upside down on a HECM personally. As a society/taxpayers, we obviously can, and of course that could have ramifications.
I suspect you’ll see Friday’s post as a bit of a rebuttal. I agree with your last point- why complicate my life if I don’t have to?
This was a fascinating read, I had no idea that there was so much to know about reverse mortgages. In particular, I didn’t know that just about anyone could apply for one if you feel like you could use the help. That must be a load off of some people’s shoulders, especially if they’ve recently gone through hard times like a divorce or death in the family.