Advisor Practice, Real Estate

A Reverse Mortgage Is An Arrow In The Quiver, But Maybe Not The First To Be Pulled

August 24, 2023

I was going through my email inbox and this article from Financial Advisor caught my eye.  I have been an advocate of reverse mortgages as a supplement to retirement income for over fifteen years.   I am aware of the risks and drawbacks, but the characteristics of the arrangements can be beneficial to certain retirees.  The article addresses the advantages and the disadvantages of the financial contracts in a straightforward manner, which I found helpful.  I bring write this because I have seen an uptick in marketing messages promoting reverse mortgages, and a lot of activity denouncing them by professionals and non-professionals alike.

After a rocky start on the 70s and 80s, HUD standardized reverse mortgages in 1989 with the Home Equity Conversion Mortgage (HECM).  As with so many financial products, I am drawn to the original and simplest concept and design of the HECM, based on a single retiree with a home owned free and clear.  The borrower will receive a  monthly income based on her age and the value of the home.  The payments continue until the borrower is no longer living in the home or the home is sold.  The payments made to the borrower are loan proceeds, so the loan balance increases with each payment.  The loan balance also increases with the interest owed on the loan plus any fess or expenses related to the loan.  The loan matures when the borrower no longer lives in the home, whether it comes due to sale, incapacity, or death.  The borrower (or her estate) continues to own the home at maturity, but must pay off the loan.  Typically, the home is sold and the proceeds go to the lender,  and sale proceeds in excess of the loan balance are retained by the borrower (or her estate).  This seems a very efficient means to access the equity in a home to provide a predictable income stream for a retiree.  An HECM could provide the same steady income stream that an annuity would, without having to sell the house or take a loan on it in order to purchase an annuity.

The potential borrowers who would benefit from reverse mortgage as in the above scenario  are limited.  Some of the characteristics:

1. Large amount of equity in the primary residence;
2. Fairly short (actuarial) expected life;
3. Health that would lead to an expectation of reaching that expected life;
4. Guarantied income sources (Social Security and Pension) that fall significantly short of expenses for basic life necessities.

What else is needed? Education. The HUD program has an education requirement, but retirees will often need reinforcement.  This isn’t necessarily an easy concept to grasp.  the client’s heirs may also need education, as it can be confusing to see that a home that was paid off twenty years earlier now has a significant mortgage against it.  It’s better to bring them up to speed when the client is considering the transaction than explaining the rationale when  the heirs are taking inventory of the estate.

A revers mortgage is a tool ion the financial toolbox, but it’s not a hammer or screwdriver.  It is more like a spark plug attachment for a socket wrench: not very useful in most common settings, but invaluable in a highly specific situation.