Gone are the days when a reverse mortgage is viewed as an eleventh-hour attempt for people in next to no time will join the ‘broke’ world record.
Reverse mortgage is now viewed as a significant financial planning tool for retirees with or without home equity and financial assets. This is not limited to the United States. Even countries in Asia have followed suit.
In May of 2012, the Bangkok Post reported that a Thailand-based company is conducting a feasibility study on reverse mortgage. If the company’s plan of offering loans with houses as collateral materialize, it will be the first of its kind in Thailand. Hong Kong and Korea were among the firsts in the region to introduce reverse mortgage.
It suffices to say that reverse mortgage is now being elevated from an observer to a duly-recognized member of the retirement planning toolbox.
What Is A Reverse Mortgage?
In the U.S., a reverse mortgage is a loan made available by the Department of Housing and Urban Development (HUD) for senior homeowners at least 62 years old.
Under the program, a portion of the home equity is used as a collateral or security. The loan will only be repaid when the homeowner passes away or permanently moves out of the property.
A retiree has the option to take the loan as:
1.) A lump sum (lump sum of cash at closing).
2.) As a term (equal monthly payments for a fixed number of years).
3.) As a tenure (equal monthly payments as long as the homeowner lives in the property).
4.) As a line of credit (draw any amount at any time until the line of credit is exhausted).
5.) A combination of the above choices.
No minimum income or credit requirements are demanded to qualify for a reverse mortgage. As a matter of fact, lenders barely glance at credit history, as long as the borrower has not defaulted on any federal debt. Rather, factors like age, value of home, interest rate, and location of the property determined the estimated loan calculated via a reverse mortgage calculator.
Aside from the aforementioned, reverse mortgage is not subject to income tax payment (tax free) and does not affect senior’s Social Security or Medicare benefits. While reverse mortgage can be indeed a saving grace for retirees with troubled finances, it can also serve as a spending booster for retirees with life annuities.
In Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income published in the Journal of Financial Planning, authors Barry and Stephen Sacks developed two approaches to home equity called reverse-mortgage-first and coordinated strategy. The authors argued that the two approaches to the reverse mortgage credit line could provide retirees a secure long-term cash flow.
In the current scheme, a reverse mortgage is considered as a last resort, only to be pursued when a retiree is facing imminent risk of financial ruin. In the reverse-mortgage-first strategy, a retiree utilizes reverse mortgage to allow growth in the portfolio of securities (401k, individual retirement account, etc.) during the early phase of retirement. The retiree abstains from withdrawing any amount in the portfolio until the reverse mortgage credit line is exhausted.
In the coordinated strategy, a retiree utilizes reverse mortgage during the portfolio’s positive performance in the early years of retirement. A retiree effects withdrawal only when the portfolio’s performance is negative.
According to Barry and Stephen Sacks, when a reverse mortgage is utilized in either of the two approaches, there is a substantial increase in a retiree’s solvency. In the current scheme, where in a reverse mortgage is considered as a last recourse, the cash flow survival rate for 30 years at 6 percent withdrawal rate is 50 percent. In either reverse-mortgage-first or coordinated strategy, the cash flow survival rate is up to 80 percent.
This is to say that sustained solvency throughout retirement is not a starry-eyed idealism. It is possible especially when a reverse mortgage is taken at the early-phase of retirement.
This also means that the tide in retirement planning is changing, and reverse mortgage is gaining some acknowledgement from financial planners and authorities worldwide.