Unlocking more than just cash and explore the unexpected advantages of reverse mortgages for a secure retirement
What would retirement be like if you didn’t have to make a monthly loan payment?
Imagine the financial freedom you could achieve if you no longer had to make a monthly mortgage payment. Reverse mortgages can be strategically utilized to manage and reduce debt obligations, enabling retirees to maintain financial stability and enhance their lifestyle.
Understanding the Growing Debt Burden
According to the Consumer Financial Protection Bureau, an increasing number of retirees carry mortgage debt into their retirement years. Some studies estimate that 50-68% of new retirees will have some form of loan payment, including home equity loans and lines of credit. For the mass-affluent baby boomer demographic, this percentage might be even higher.
Consider the last social gathering you attended where you spoke with homeowners over the age of 55. How many of them had a mortgage, home equity loan or line of credit against their property? It’s likely that a significant portion of them did. In fact, it wouldn’t be surprising if the number was somewhere between 75-99%. This highlights the prevalent issue of mortgage debt among older homeowners, making the case for exploring debt management strategies such as reverse mortgages.
For retirees aged 75 and older, housing expenses, including mortgages, property taxes, insurance, utilities and home maintenance, account for a substantial 43% of their monthly spending. With low savings rates, longer life expectancies and global uncertainty, eliminating a monthly mortgage payment and creating additional cash flow could be a considerable relief.
Reverse Mortgages: A Brief Overview
A reverse mortgage is a loan available to homeowners aged 62 or older, allowing them to convert a portion of their home’s value into tax-free dollars without giving up home ownership or title and without making monthly loan payments. The loan amount is based on the age of the youngest borrower, the home’s value and current interest rates. This is important: a reverse mortgage must be the first mortgage on the property, meaning any existing loans must be paid off with the reverse mortgage proceeds before the homeowner can access the remaining funds.
Today, let’s consider the impact of eliminating a mandatory monthly mortgage payment.
Case Study: Pierce and Linda
Meet Pierce and Linda, a 65-year-old couple planning to retire at the end of the year. Here are their financial details:
- Home value: $650,000
- Mortgage: $200,000
- Monthly principal and interest payment: $1,750
- Total retirement savings: $650,000
- Desired initial withdrawal amount: $45,000 per year (around 7%)
They are concerned about running out of savings or having to cut back on their lifestyle to make their savings last.
While researching their retirement success rate, Pierce and Linda discovered that many financial advisors and online calculators suggest a safe initial withdrawal rate of around 4%, which for them would be $26,000 per year instead of $45,000.
This realization was disappointing, but it prompted them to explore alternative options. Through further research, Pierce and Linda decided to consider a reverse mortgage to see if it could work for them.
Although they are fully comfortable making their monthly payment, they want to explore all possibilities, especially if it could increase the amount of spending they could enjoy without jeopardizing their nest egg.
During their research, they encountered two thought-provoking questions:
- What would retirement be like if you didn’t have to make a mandatory monthly mortgage payment?
- If you had a choice, would you rather your monthly payment be mandatory or voluntary?
These questions led them to consider a reverse mortgage as a viable option to enhance their retirement plan.
The Reverse Mortgage Solution
Based on their ages, home value and current interest rates, Pierce and Linda qualify for a reverse mortgage of $216,300. After paying off their $200,000 mortgage, they have a remaining line of credit of $16,300.
Let’s explore 10 retirement-enhancing benefits of eliminating their mandatory monthly loan payment.
1. Extending Retirement Savings
Years ago, my friend and mentor Ed Slott, CPA, asked me: “How much money does a client save when they use a reverse mortgage to eliminate their existing payments?” Initially, I thought the answer was obvious: in the case of Pierce and Linda, they would save $1,750 a month.
“Not necessarily,” he replied.
What he explained next was eye-opening.
Eliminating a $1,750 monthly mortgage payment translates to significant savings for retirees like Pierce and Linda. With $650,000 in tax-deferred accounts like IRAs or 401(k)s, they would need to withdraw approximately $2,250 monthly (considering taxes) to net the $1,750 needed to cover their mortgage payment.
By using a reverse mortgage to eliminate this payment, they retain around $27,000 annually in their savings ($2,250 x 12). This substantial retention can significantly extend the longevity of their retirement funds, ensuring greater financial stability throughout their retirement years.
By leveraging a reverse mortgage to eliminate their monthly mortgage payments, Pierce and Linda can preserve their savings, potentially extending their retirement funds significantly, providing them with greater financial security and peace of mind.
2. Reducing Income Taxes
By retaining nearly $27,000 in pre-tax dollars, Pierce and Linda not only lower their income taxes but also reduce their provisional income, which could prevent their Social Security benefits from being taxed.
3. Bridging the Budget Gap
Initially, Pierce and Linda desired an annual withdrawal of $45,000 but considered a more conservative $26,000. The $19,000 difference can be bridged by the reverse mortgage. By eliminating their mortgage payment, they free up $27,000 per year in pretax dollars. Meaning they only need to withdraw around $18,000 from their retirement accounts in the first year.
Looks like they can use the additional dollars per month to enhance their lifestyle, travel and enjoy the go-go years of retirement. In other words, they can have their cake and eat it too!
4. Supporting Grandchildren’s Education
With the extra $1,750 per month saved from the reverse mortgage, Pierce and Linda could contribute to their grandchildren’s education. This money could provide a monthly tuition stipend, a gift or even a low-interest loan, offering significant financial support and creating a lasting legacy. The rising costs of higher education can be a burden on younger generations, and this contribution can make a meaningful impact on their grandchildren’s lives and futures.
5. Funding Life Insurance Policies
The monthly savings can be directed toward purchasing cash value life insurance policies for their grandchildren. These policies are inexpensive, offer tax-deferred growth and provide guaranteed returns, ensuring financial security for future generations. By securing life insurance for their grandchildren, Pierce and Linda can help ensure that their family has a financial safety net in place, which can grow over time and provide substantial benefits as their grandchildren reach adulthood.
6. Enhancing Lifestyle and Covering Healthcare Costs
Pierce and Linda can use the additional $1,750 per month to cover unexpected healthcare costs. This extra cash flow can provide peace of mind and improve their quality of life. Retirees often worry about healthcare expenses, and having a reserve from their reverse mortgage savings can help cover out-of-pocket medical costs, prescriptions, or even long-term care, ensuring they receive the best possible care without financial stress.
7. Delaying Social Security Benefits
By using the funds from the reverse mortgage to cover their expenses, Pierce and Linda can delay claiming Social Security benefits. This strategy can result in a higher monthly benefit when they do decide to claim, increasing their long-term financial security. Delaying Social Security can be a crucial strategy for many retirees, as each year they defer can significantly increase their benefits, providing more substantial income later in life when they may need it most.
8. Protecting Against Insurance Policy Lapses
The additional monthly savings can help ensure that premiums for life insurance, long-term care insurance or medical coverage plans are paid consistently, protecting these essential policies from lapsing due to financial strain. Insurance policies are vital for protecting against unexpected events. Maintaining them is crucial for long-term financial stability and security.
9. Creating an Emergency Fund
Pierce and Linda can allocate part of their monthly savings to build a robust emergency fund. This fund can provide a financial cushion for unexpected expenses, reducing stress and ensuring they are prepared for any unforeseen circumstances. An emergency fund is a critical component of a sound financial plan, offering protection against unplanned events like home repairs, medical emergencies or other sudden expenses that can arise during retirement.
10. Increasing Charitable Giving
With the additional $1,750 per month saved from eliminating their mortgage payment through a reverse mortgage, Pierce and Linda can increase their charitable contributions. This extra cash flow allows them to support causes they care about more substantially and consistently. Charitable giving can provide personal fulfillment and potentially offer tax benefits, enhancing both their financial and emotional well-being. By being able to give more, they can make a greater impact on their community and the organizations they support, leaving a lasting legacy.
Conclusion
The benefits of eliminating a mandatory monthly mortgage payment through a reverse mortgage are extensive. From extending retirement savings and reducing income taxes to supporting family and maintaining crucial insurance policies, the financial freedom gained can significantly enhance a retiree’s quality of life. Reverse mortgages provide a flexible, strategic solution to managing retirement finances, allowing retirees to focus on enjoying their golden years with less financial stress. By considering a reverse mortgage, retirees like Pierce and Linda can unlock the equity in their homes and use it to secure a more comfortable and financially stable retirement.