Bridging the Gap Between Living Expenses and Social Security Income with a Reverse Mortgage
Planning for and maintaining retirement can seem like a difficult task, especially when it comes down to the finances of it. Figuring out how to bridge an income gap between living expenses and Social Security is a common problem for: If this sounds like any of your clients, then let’s take a look at how a reverse mortgage can bridge this gap, and how it compares to some alternative solutions: Solution 1: Getting a Reverse Mortgage Nearly 80% of senior households own a home, making a reverse mortgage a very real option for bridging a gap between Social Security and expenses. Whether your client owns their home outright, or has a traditional mortgage on it, a reverse mortgage can be an asset in their retirement strategy. By using the equity in your client’s home, a reverse mortgage makes payments to the homeowner in the form of a lump sum, line of credit, monthly payments, or a combination. A big appeal of the reverse mortgage is that no mortgage payments are required;* the loan is typically paid back when the last borrower leaves the home or passes away. Additionally, one of the best features of a reverse mortgage is that it is a non-recourse loan, meaning it can only be paid back from the home and the borrower is not liable beyond the value of the home when the loan comes due. Typically, the loan is paid back through the sale of the home or refinancing the property into a traditional mortgage. *Borrower must pay property taxes, insurance, HOA fees and maintain the property. EXAMPLE In this illustration, not only does the current monthly mortgage payment of the traditional mortgage get eliminated, but the client also receives a certain amount from their line of credit on a monthly basis, over the specified period of time. By utilizing a reverse mortgage, the client bridges their income gap for those 8 years, is able to maximize their Social Security benefits, eliminates their required monthly mortgage payment,* and has access to a growing line of credit for future and emergency use. Example uses a 62-year-old client with a $800,000 home value, receiving a total principal limit of $271,200 based on an expected rate of 6.370% (11/9/22). See the estimated loan details here. *Borrower must pay property taxes, insurance, HOA fees and maintain the property. How a Reverse Mortgage Compares to Other Solutions Alternative Solution No. 1: Work part-time This option is fairly straightforward in how it can help bridge an income gap between expenses and Social Security: every hour worked means more income. Some seniors may find this appealing, especially as a way to “phase out” of work and into full retirement. However, if your client is considering working and wants to receive Social Security benefits, they need to be mindful of their full retirement age. If they are not yet at full retirement age and their income is more than the yearly earnings limit, then their Social Security benefit will be reduced. If your client is of full retirement age, then their benefits will not be reduced, regardless of the income they earn. Of course, if your client doesn’t want to work, then this isn’t a great option for them in their golden years. A reverse mortgage can get them the income they need without requiring them to work. If your client is keen on working, then this could even be an option alongside a reverse mortgage, providing two solutions to bridge the gap. Alternative Solution No. 2: Use savings Another option to bridge an income gap is to utilize savings. This can mean dipping into a regular savings account, an IRA or 401(k), or even a whole life insurance policy. When considering this approach, your client should be sure to think about what withdrawals will be taxable, if any fees will apply, and they should determine the timing and amounts that would be most suitable for them. When compared to a reverse mortgage, we start to see where this solution’s limitations are. For instance, the savings can be depleted before the person passes, whereas the funds from a reverse mortgage can be structure for a specific period of time (term) or for life (tenure). A savings account may not be as subject to the market conditions since you’ll always have the principal balance, whereas the unused portion of the line of credit can actually increase in value due to its growth rate. Income from some types of savings or retirement accounts may be taxable, whereas in general, income from a reverse mortgage is not. All clients should be advised to discuss their specific situation with their financial planner or advisor to ensure a reverse mortgage is the right financial solution. Alternative Solution No. 3: Deferred or immediate income annuity Finally, purchasing an income annuity1 can be a solution to bridging an income gap, however you may have to deplete the cash or savings you have on hand to purchase it. A specifically designed reverse mortgage, can also provide a guaranteed income stream for a desired time frame, regardless of the ever-changing market or economic landscape. With an immediate annuity, the person makes one lump-sum contribution that is converted to a steady income stream for the specified duration. A deferred annuity allows the person to make a lump-sum, or multiple contributions, during the accumulation phase and is then converted to an income stream during the specified duration. In contrast, most reverse mortgages do not require the borrower to pay into the loan, don’t require a monthly mortgage payment,* and the income stream can be set up to continue until the borrower passes via the tenure structure. Additionally, most income annuities do not give the person access to the principal, whereas with a reverse mortgage line of credit, any payments made to the loan balance increases the available funds. 1. Deferred Income Annuity contracts are irrevocable, have no cash surrender value and no withdrawals are permitted prior to the income start date. *Borrower must pay property taxes, insurance, HOA fees and
What Is A Home Equity Conversion Mortgage?
Updated: Jun 9, 2023, 2:14pm Getty A home equity conversion mortgage (HECM) is a reverse mortgage that enables seniors to access their home equity without selling their homes or making monthly mortgage payments. HECMs are the most popular type of reverse mortgage available. Nearly 65,000 senior homeowners took out a HECM from Oct. 1, 2021 through Sept. 30, 2022, according to the National Reverse Mortgage Lenders Association. How Do Home Equity Conversion Mortgages Work? Instead of gradually paying a lender back each month, all the money you borrow with a HECM is due when you move out of your house. That sum consists of the principal, interest and mortgage insurance—and closing costs if you finance them. Your move might be caused by your death, a need for assisted living or another reason. You can borrow the money as a: The lump sum has a fixed interest rate while the other options have a variable interest rate. Regardless of the option you choose, you can use your HECM proceeds however you want and continue to own your home. The amount you can borrow is based on three factors: Experts: Consider HECM Lines of Credit Like any mortgage product, HECMs come with notable risks, including being used to scam seniors out of their home equity. However, these loans also have a legitimate purpose and can be a good tool for borrowers who need to supplement their income during their retirement years. Some retirement planning experts have advocated for broader use of the HECM line of credit option. They say seniors should set one up as soon as they’re eligible. Even if you don’t need it now, the line of credit grows over time and can provide a diversified source of retirement income. For example, you could tap your home equity in years when you might otherwise have to sell investments at a loss to pay for living expenses or medical costs. You won’t pay interest unless you actually borrow money. But you’ll pay closing costs to set up the line of credit, whether you use it or not—which can be a deterrent. Who Is Eligible for a HECM Loan? You must meet these basic requirements to qualify for a HECM: How To Apply for a HECM Loan HECM loans are only available through reverse mortgage lenders approved by the Federal Housing Administration (FHA). You can find one through the FHA’s website or find lenders first, then check with the FHA to make sure they’re approved. If possible, it’s best to get preapproved or prequalify with multiple lenders to find the best offer before submitting an official application. Preapproval and prequalification have no impact on your credit score. The government has many requirements lenders have to follow when issuing HECMs. However, it doesn’t tell lenders what interest rate to charge. A lender with lower fees may charge a higher interest rate. Fees and other closing costs can vary by lender, although HECM lenders can’t charge more than $6,000 in origination fees. No matter which lender you choose, you can shop around for better prices on third-party closing costs, such as title insurance and closing services. You’ll also want to pay attention to how much and how often the interest rate can change if you apply for a HECM with a variable rate. HECM vs. Reverse Mortgage All HECMs are reverse mortgages, but not all reverse mortgages are HECMs. Some lenders offer their own proprietary reverse mortgages. HECMs are tightly regulated by HUD, with protections for both borrowers and lenders. All lenders must follow HUD’s rules. Proprietary reverse mortgages, on the other hand, have more lenient requirements, with more room for lenders to set their own parameters. Mortgage Insurance Premiums One of the most notable rules is that you’ll have to pay mortgage insurance premiums (MIPs) when you get a HECM. The upfront premium costs 2% of your home’s value (the maximum claim amount); ongoing premiums cost 0.5% of the outstanding loan balance each year. HECMs have a government guarantee that limits lenders’ losses if the borrower owes more than the home is worth when the mortgage is due. This guarantee also prevents borrowers and their heirs from having to make up any shortfall. As a result, all HECM borrowers must pay MIPs that go into the guarantee fund that helps make these loans possible. Proprietary reverse mortgages don’t have this mortgage insurance requirement. Age Requirements Another key difference is that you must be at least 62 years old to get a HECM. You may be able to get a proprietary reverse mortgage at a younger age, such as 55, depending on the lender and your state. Borrowing Limits A proprietary reverse mortgage also allows you to borrow far more—into the millions, depending on the lender and how much your home is worth. It can be a good option if you want to borrow more than HUD allows with a HECM, based on a maximum home value of $1,089,300 in 2023. HECM Alternatives A key reason for choosing a HECM is that you don’t meet the income or credit requirements to get another type of loan. But there are many other ways to use your home equity in retirement—and borrow without using your home as collateral. You don’t have to be working to qualify for a loan. You can get a mortgage after retirement (or get another type of loan) based on your retirement income, including Social Security, Supplemental Security Income, retirement account withdrawals, pension payments and more. A financial advisor can help you decide whether a HECM or an alternative option below may best meet your goals. By Amy Fontinelli