Combating inflation with a reverse mortgage. What retirees must know
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Many older Americans worry that they will be able to survive their savings, and those fears have been compounded by the recent spikes in inflation that are devouring retirees’ nest egg.
The consumer price index rose by 0.8% in April compared with March and by 4.2% compared with the previous year. This is the biggest jump since September 2008.
As retirees weigh options to maintain purchasing power, financial experts may say that adding a reverse mortgage to a retirement plan could offer inflation protection.
“There are more and more people taking this strategically,” said Don Graves, president of the Housing Wealth Institute and author of Housing Wealth: A Guide for Advisors to Mortgage Reversal.
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While Americans have record levels of home equity, it has not been easy to access during the pandemic.
Several large banks stopped offering home credit lines in the face of economic uncertainty. As a result, some cash-strapped seniors turned to mortgages, especially during the stock market slumps.
But reverse mortgages can also be a proactive strategy, said Wade Pfau, professor of retirement income at the American College of Financial Services.
How a reverse mortgage works
Reverse mortgages – also known as HECMs (Home Equity Conversion Mortgage) – offer senior citizens aged 62 and over the opportunity to borrow money from the equity of their home.
These fixed or floating rate loans are designed for older Americans who want to stay in their single family home.
The floating rate option offers a line of credit with no obligation to withdraw funds, and the unused balance can continue to grow over time. (The fixed income version doesn’t offer the same benefit, making it less useful in fighting inflation.)
The old adage was to wait until you ran out of money and then take out a reverse mortgage. That’s absolutely not the way it’s used right now.
President of the Housing Wealth Institute
As a rule, older retirees can borrow a larger amount of equity.
For example, a 62 year old homeowner can borrow about 52% of the value of their home at an expected rate of 3%. The percentage rises to nearly 61% by the age of 75, Pfau said.
Floating rates could currently range from 2.5% to 4% depending on short-term floating rates, which are often tied to Treasurys, he said.
For the line of credit, heirs can repay the loan once the borrower dies so they can keep or sell the property.
Reverse mortgage for inflation protection
Typically, retirees spend their investment portfolios while receiving the home equity.
However, research has found that adding a reverse mortgage to a retirement plan could offer an unexpected benefit, Pfau said.
“The bigger impact is that you relieve the pressure on the portfolio in retirement,” he said.
Research shows that a reverse mortgage can give some retirees more money to spend while their portfolio offers more growth opportunities.
The benefit of opening a reverse mortgage line of credit early, especially with low interest rates, is that the retiree may now be able to borrow more. This step may allow more time for the untapped equilibrium to grow.
In addition, higher inflation will lead to faster credit line growth, he said.
“For anyone contemplating a reverse mortgage, when you are in the house you think you will be staying in can be very valuable to open it before interest rates are higher,” he added.
Disadvantages of reverse mortgages
One of the biggest drawbacks to a reverse mortgage can be the cost.
Retirees pay 2% of the estimated home value for mortgage insurance premiums upfront, plus 0.5% of the outstanding amount each year for the life of the loan.
The origination fee is 2% of the first $ 200,000 and 1% for up to $ 6,000 beyond that.
Third party fees like valuation, title search, inspection and other fees are typically 1% of the home value.
For example, let’s say a retiree has a home for $ 400,000. They would pay $ 8,000 for mortgage insurance premiums, $ 6,000 for the origination fee, and about $ 3,000 for third-party fees, Graves said.
In addition to costs, retirees need a sophisticated spending strategy, Pfau said.
Some might find it tempting to blow through newly developed home equity, which could wreak havoc on their retirement plan, he said.
Still, reverse mortgages can be worth a look for retirees worried about their spending power.
“The old adage was to wait until you ran out of money and then take out a reverse mortgage,” Graves said. “It is absolutely not used that way at the moment.”