It’s best to plan for retirement cash flow needs, and now is an ideal time for many homeowners to look at their options. In fact, those that believe that a reverse mortgage is a last resort may find that their options could be limited if they wait.
Keep in mind, the reverse mortgage industry must be careful not to create an undue sense of urgency. Advertisements that encourage seniors to “Act now” and “Don’t miss this time-sensitive opportunity” for their financial product are often irresponsible and are generally considered unethical by regulators.
Therefore, don’t misinterpret my intentions with this title. In this article, I simply hope to educate the reverse mortgage novice on certain product details and current market conditions that could impact their retirement planning decisions.
1. Credit deficiencies can reduce your options
One difficult challenge for any reverse mortgage professional is getting a homeowner qualified after they’ve missed a mortgage payment or property charge payment. Since 2015, each lender must examine every applicant’s credit history and property charge history. If a homeowner falls short of HUD’s definition of “satisfactory,” then we’ll often need to set-aside enough principal to pay property taxes and homeowner insurance for that borrower over their expected lifetime. For many younger homeowners in high-tax regions, that could be as much as $100,000 of their principal that won’t be accessible. Does that leave the borrower with enough principal to pay off their existing mortgage and closing costs? Sadly, the answer is often no.
If you are running out of cash and might be forced to miss a required mortgage payment, property charge payment, installment debt, and even revolving debt, that could be a problem. It’s very important that you investigate your reverse mortgage options before those deficiencies occur.
2. Interest rates are very low right now
Keep in mind, many reverse mortgage products consider two types of rates – long-term rates, which we call “expected rates,” and short-term rates which we call the “note rate” or “interest rate.” Some will ask, “why do interest rate even matter? After all, there’s no required monthly principal and interest mortgage payment with a reverse mortgage, right?”
That’s correct, but there are two reasons why today’s low-interest rate environment makes reverse mortgages more attractive:
– When long-term rates are low, HUD allows lenders to offer homeowners a higher percentage of their home’s value. If you don’t need the additional funds, the unused portion is securely held in a line-of-credit that may be available for future use. In essence, today’s low expected rates make the initial line of credit larger.
– When short-term rates are low, the amounts drawn from the reverse mortgage will accrue interest at much slower rates. Recently, some homeowners were seduced by record-low rates on the 30-year fixed-rate mortgage. However, many failed to notice that rates on the federally insured reverse mortgage product were even lower.
3. We are in a bear market and facing a recession
For retirees, this is a very poor time to draw monthly cash needs from an asset that’s declining in value. Some advisors will call this “sequence of returns risk.” For younger investors, a bear market is a great opportunity to buy more shares at reduced prices. However, retirees are pulling money OUT of the market. This means they are selling investments at the worst possible time. Some call this “volatility drain.”
Consider a $100 investment that declines 50% to $50. Many investors will incorrectly assume that a 50% gain will bring them back to their original value. But of course, that investor would need a 100% gain to get back on track.
Now imagine this investor was a retiree who removed $10 from the portfolio when the market was down. That retiree would need a 150% gain ($60) to get from $40 back to $100. That is the essence of volatility drain.
Fortunately, home values have remained stable, for now. Tax-free distributions from the home equity nest egg can potentially reduce your tax liability and protect a struggling retirement portfolio during this crisis.
If you, or a loved one, feels the need to leverage their home equity for any reason (e.g. retirement cash flow, in-home care, home repairs, tax strategies, etc.), then please do your research. Reach out to a qualified reverse mortgage professional.
Dan Hultquist, MBA, CRMP, VP Organizational Development for Finance of America Reverse (FAR) LLC