The millions of Americans who haven’t saved enough money for retirement still have a potential safety net: their home equity. But recent changes to reverse mortgages mean seniors and their families may have tougher decisions to make.
Reverse mortgages allow people 62 and older to tap their home equity without having to pay the money back until they move out, sell the house or die. Borrowers can take payouts as lump sums, monthly checks or through a line of credit that can be tapped at will. The reverse mortgage debt grows over time, typically at variable interest rates, and may deplete all the equity in the home, leaving nothing for heirs. If the home is worth less than the reverse mortgage balance, though, borrowers and their heirs can’t be held responsible for that loss.
The loans earned a bad reputation as commission-hungry salespeople preyed on seniors who didn’t understand the loans’ complexities or who had financial problems so severe that they quickly burned through the money. Another problem was unscrupulous advisers who urged people to use their equity to buy questionable investments, including expensive annuities.
Over the years, the U.S. Department of Housing and Urban Development, which oversees the Home Equity Conversion Mortgage program that insures most reverse mortgages, implemented changes that made the loans safer and, in some cases, cheaper.
Costs fell enough that fee-only financial planners who traditionally had shunned these loans started to recommend them to wealthier clients as a portfolio protection strategy. People could borrow against a reverse mortgage line of credit when markets were down, rather than selling shares at their lows. Research, much of it published in the influential Journal of Financial Planning, found the strategy allowed people to spend more with less risk of running out of money in retirement.
In October 2017, the Trump administration reduced the amount people could borrow and increased the costs, raising the upfront mortgage insurance premium for a line of credit from 0.5 percent to 2 percent of a home’s value. HUD Secretary Ben Carson cited losses in the program and a need to put it on a “more sustainable footing.”
Using reverse mortgages for portfolio protection can still make sense, but the strategy is a harder sell now with the changes, says certified financial planner Michael Kitces of Columbia, Maryland, who was an early advocate of the strategy.
“For a reasonably affluent client that has a $300,000 or $500,000 house, that’s $6,000 to $10,000 of upfront costs just in case you might ever need the line of credit,” Kitces says. “It’s just too much of a mental upfront hurdle for most clients.”
Even before reverse mortgages became more expensive, the Consumer Financial Protection Bureau warned last year against another strategy that some financial advisers were promoting: using the loans to delay claiming Social Security.
Social Security benefits grow about 7 to 8 percent each year they’re delayed after age 62, but the costs and risks of reverse mortgages generally exceed the cumulative lifetime benefits of bigger Social Security checks, the CFPB says. Borrowing money for living expenses early in retirement can mean there’s not enough left to handle later financial shocks, such as long-term care.
The CFPB took action in 2016 against three reverse mortgage lenders for deceptive advertising that claimed people couldn’t lose their homes. Although borrowers don’t have to make monthly payments on the loans, they do have to keep up with property taxes, insurance and maintenance.
These days, reverse mortgages may be best suited for the way many people have traditionally used them: to pay off existing mortgages so they can eliminate monthly payments or to generate monthly income in retirement, says Wade Pfau , professor of retirement income at The American College of Financial Services in Bryn Mawr, Pennsylvania. Those borrowers actually benefited from some of the changes, which included a reduction in annual insurance premiums on borrowed amounts.
“Your loan balance grows more slowly, which is good,” says Pfau, the author of the recently updated book “Reverse Mortgages.”
The brief heyday of the portfolio protection strategy may have had a silver lining: It got more financial planners thinking about a product they used to shun. Kristi Sullivan, a certified financial planner in Denver, says she now talks to clients more often about reverse mortgages and the potential uses of home equity in retirement.
“Some people are still reluctant to discuss the option, but more and more are open to listen and look at financial models using a reverse mortgage,” Sullivan says.