Reverse mortgages are traditionally thought of as a last-resort option for seniors who want to stay in their homes but have little resources and few options left.
But research has proven otherwise.
In recent years, a number of retirement experts and financial planners have extolled the ways a reverse mortgage can be used to generate a more positive financial outcome in retirement.
Of course, for the loan to make sense, the borrower must be at least 62 and should be committed to remaining in the home for a number of years, ideally using the loan as a means to age in place.
If this is the case, a reverse mortgage can be a beneficial financial planning tool for more well-off borrowers in a number of ways.
First, as part of taking the loan, a borrower’s original mortgage balance must be paid, therefore eliminating their monthly mortgage payment and freeing up cash, which is clearly beneficial for a retiree living on a fixed income.
Second, a borrower can use the proceeds from the loan to fund expenses and delay taking Social Security. This maximizes the benefit one gets from Social Security, as the later you draw it, the more money you can access.
Third – and this is the strategy most often touted by retirement researchers – borrowers can establish a growing reverse mortgage line of credit to drawn upon when needed.
The idea is to use the credit line as a safety net in the event funds are needed but your stock portfolio or other assets are down. This way, borrowers can allow their assets to rebound, using the reverse mortgage proceeds instead to cover expenses.
Wade Pfau, a well-known retirement researcher and professor of Retirement Income at the American College of Financial Services, said studies have proven that using a reverse mortgage as a last resort offers the least benefit.
“For someone who ends up needing [the loan] as a last resort, they could have surely created more line of credit to help at that point by setting up the reverse mortgage earlier on in retirement and letting the line of credit grow until it is needed,” Pfau explained. “This is why last-resort strategies end up looking the worst in financial planning research about reverse mortgages.”
Jamie Hopkins, director of retirement research at Carson Group, said that a proactive strategy is especially important when it comes to home equity.
“One problem with waiting to deploy home equity toward the end of retirement is that home equity grows more slowly than other investable assets in general,” Hopkins explained. “Most homes just keep pace with inflation and provide no real return over it, and many senior-owned homes actually see a decline in value because seniors don’t always keep up with the newest and best home features and remodels.”
Instead, both Pfau and Hopkins say establishing a HECM line of credit earlier on can help a retiree better manage their resources.
“A HECM or other line of credit can provide cash flow and spending flexibility for retirees. This needs to be the focus,” Hopkins said. “Can using a reverse mortgage or line of credit improve the client’s life? If the answer is yes, then it should be explored.”
Hopkins added, though, that it's important to fully understand the terms of the loan.
“On the flip side, reverse mortgages are a form of borrowing, so all costs and downsides also need to be understood,” he said.
Pfau agreed with an early deployment strategy.
“The line of credit creates many opportunities to help manage the new types of risks retirees face, such as the amplified impacts of market volatility caused by the sequence of returns,” Pfau said.
“The reverse mortgage can help to protect the investment portfolio from this risk in any number of ways, such as reducing the early retirement distribution rate to make mortgage payments, managing the delay of Social Security benefits, or coordinating portfolio distributions with reverse mortgage proceeds to cover a retirement spending goal,” he added. “It's all about creating the opportunity for greater line of credit growth by the time it is needed.”