It isn’t surprising so many homeowners, family members and trusted advisors struggle over whether a reverse mortgage should be considered. It touches heartfelt beliefs about home ownership, legacy, and debt. The conflict is between equity security and income security. Which is better? This can be a tough choice that should not be made lightly. Even tougher is how to recommend or decide on one or the other during such uncertain economic times.
Equity Security rests on the time-honored tradition that owning one’s home debt-free is a fundamental of financial independence. If your house is worth $500,000 then you are worth $500,000. Your family knows what they will inherit and you are free of debt. It’s pretty hard to argue against that.
The problem is that the theory of equity security relies on the great assumptions of real estate: “Your home always goes up in value, you can always sell your home, and you can always get a mortgage.” During the Great Recession we found out the more you need money, the less the bank wants to lend it. It also turned out home values can go both up and down. In a down real estate market, turn times are longer and prices are lower.
Now we know that just like any other areas of finance, home values are subject to market conditions which can fluctuate. Mortgage rules can impact sales and our ability to refinance.
Income Security is more about a diversified and re-balanced portfolio. It sees the home as one of many assets to be managed. It is about access to funds and the strategies for managing all of our money. After all, a house may be worth $500,000, but if no one is buying or the bank isn’t lending, we can’t spend any of it. That is why houses aren’t usually considered a liquid asset.
Like so much of retirement income planning, there are tradeoffs, like how much I want to spend now vs. how much I want to be able to spend later. It shouldn’t be surprising there can be trade-offs with the home, too.
The conflict is between the home as a sanctuary and the home as an asset. A reverse mortgage is simply a way to access the trapped wealth in the property. It converts a portion of the home’s value into money that can be spent. That is not the complicated part.
The complicated part is that a Home Equity Conversion Mortgage (HECM) reverse mortgage also enables you to borrow money without the requirement of making monthly payments. Instead, you borrow the money you get, plus the interest and fees accrue on the outstanding debt, compounded monthly as long as a borrower lives in the home as a primary residence. (Borrowers must keep up the property taxes and homeowner’s insurance.)
This makes the debt increase over time, instead of going down like a regular mortgage. The obvious risk here is that you could borrow more than the home is worth, completely eroding all your Equity Security. Then what happens?
Because the Federal Housing Administration (FHA) insures the loan, you or your heirs cannot owe more than the value of the home at the time of sale. So, you can’t be underwater. But you can end up using up all the equity and have nothing left when it is time to sell.
Of course, for that to happen, you would have drawn down the available equity in spite of the Cost of Living adjuster having grown the credit line over time. Next, the loan would have had to last long enough to consume the rest of the home’s worth in interest and fees compounded monthly over time.
That this is a complicated choice should not be surprising. We are talking about balancing conflicting priorities and values. It is even more difficult for financial advisors who are charged with the responsibility of helping clients protect their wealth, as well as manage finances with an eye to longevity and sustainability of assets under management. Many don’t manage home equity, so it is off their radar.
Unfortunately, we can’t count the same money twice. Whatever our goals and plans during our working years, we are now dealing with financial facts few anticipated. We don’t pick the era in which we retire. But we do get to decide how best to manage all our resources to make the most of our wealth for the longest time possible.
This has been a brief and simplistic approach to a complicated question. You are encouraged to visit my website where I blog twice a week and offer more detailed information, http://reversemortgagequestionsandconcepts.com.