How to Use a Reverse Mortgage as a Retirement Tool
By: Courtney Jorstad
November 30, 2023 • 7 minute read
If you are heading into retirement and worried that you have not saved enough, you are not alone.
A recent federal survey found that Americans in the years leading up to retirement had a median $134,000 in their retirement accounts. Even combined with Social Security benefits, this is far from being enough to retire on.
If you find yourself in a similar situation, you may wonder what options you have. Will you have to continue to work in retirement? Will you need to move in with your children? Will you need to sell your home and seriously downsize?
If you are a homeowner, one good option to consider is a home equity conversion mortgage (HECM), also known as a reverse mortgage. A HECM reverse mortgage is a unique financial product that allows you to tap into your home’s equity without taking on monthly payments that would be required if you took out a home equity loan or home equity line of credit (HELOC).
Before we dive into how a reverse mortgage may help round out your retirement portfolio, let’s go over what a reverse mortgage is and who may qualify for one.
What is a Reverse Mortgage?
A HECM reverse mortgage is a financial tool that is backed by the federal government through the U.S Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA).
In order to qualify for a reverse mortgage, at least one of the homeowners needs to be at least 62 years old, the home must be the primary residence of the borrowers, and the home needs to have significant equity built up.
If you still have a mortgage on your current home, the reverse mortgage will pay the remaining balance of that mortgage, which is how it eliminates monthly mortgage payments. Homeowners are still required to pay property taxes, homeowners insurance, any maintenance costs, and any required fees such as HOA fees.
For the remainder of the equity, homeowners are given the choice of receiving the money as a lump sum, a line of credit, monthly payments, or any combination of the three.
The amount of money reverse mortgage borrowers can receive depends on several factors such as their age, the market value of the home, and the interest rates. The FHA also puts a limit on the maximum amount that homeowners can borrow with a reverse mortgage. The current FHA lending limit for HECM reverse mortgages as of 2024 is $1,149,825.
However, if you have a home that’s worth more, most major lenders also offer jumbo loans. In most cases, homeowners can borrow up to $4 million with a jumbo loan, but the exact amount will vary depending on the lender. Jumbo loans are also considered private loans, which may incur higher interest rates.
A reverse mortgage loan becomes due when the homeowners decide to sell the home, they no longer occupy the home as their primary residence, or the last borrower or non-borrowing spouse passes away. In that case, the heirs have the option to sell the home, keep the home by paying off the loan, or leave it to the lender to handle the sale of the home.
One of the protections that homeowners have with reverse mortgages is that they are non-recourse loans. This means that neither you nor your heirs will ever owe more than the current home’s value.
Can a Reverse Mortgage Be Used as a Retirement Tool?
A reverse mortgage used to be considered a loan of last resort, but this is no longer the case.
Retirement income expert, Dr. Wade Pfau, says that reverse mortgages are now considered “a retirement income tool that can be incorporated as part of an overall efficient retirement income plan.”
“Financial planning research has shown that coordinated use of a reverse mortgage starting earlier in retirement outperforms waiting to open a reverse mortgage as a last resort option once all else has failed,” Pfau explained.
In other words, if you qualify for a reverse mortgage, it’s best not to wait until you are in a desperate situation to get one.
A reverse mortgage can be an effective part of a retirement portfolio when managed and used in a disciplined way, according to a report published in the Journal of Financial Planning.
There are no rules about how the funds from a reverse mortgage must be used. That combined with the variety of ways that reverse mortgage funds can be received, gives those in retirement a lot of options.
How a Reverse Mortgage Can Be Used for Retirement Planning
There are several ways that reverse mortgages can be an asset to your retirement portfolio, retirement savings, and investments.
Increase Cash Flow by Eliminating Mortgage Payments
While there are other ways to tap into your home’s equity such as a home equity loan, a home equity line of credit, or cash-out refinancing, those will all need to be paid back in the form of monthly payments. This is not the case with a reverse mortgage.
If borrowers still have an existing mortgage loan balance, the reverse mortgage will pay that off, and they’ll be able to eliminate their monthly mortgage payments.
By eliminating monthly mortgage payments, retirees are able to remove a fixed payment from their monthly budgets. And mortgage payments are typically one of the largest bills most homeowners have to pay.
This helps increase the cash flow each month, which can aid in helping their income and investments go further.
Reduced Strain on Retirement Investment Portfolio During Market Declines
A reverse mortgage can help offset the loss retirees may face during an economic downturn. If the market is in decline during retirement, retirees can lean on the reverse mortgage while they wait for the market to recover.
According to Pfau, this “helps manage the risk of having to sell assets at a loss after marketing downturns.”
A reverse mortgage gives those in retirement a way around this risk because it provides a source of income they can lean on during events that are outside of their control.
This is especially applicable right now as those in retirement are trying to make ends meet in the face of record inflation.
When retirees are forced to withdraw money from investment accounts when the market is down, this can greatly diminish their savings and security throughout retirement.
The Principal Limit Will Grow
While some may think it’s best to wait to take out a reverse mortgage when you think you need it, there’s an advantage to taking it out earlier in your retirement than later.
If you take out a reverse mortgage credit line, if you don’t plan to use it right away, the principal limit will grow.
“This principal limit growth will almost always allow for greater access to funds later in retirement than if you instead waited to open the reverse mortgage until later when it is first needed,” Pfau explains.
Cover Unplanned Expenses
Virginia woman Marjorie Fox decided to take out a reverse mortgage in 2018 after her husband passed away, The New York Times reported. Even though she had $150,000 in cash reserves, she wanted to have a reverse mortgage as additional backup to cover unexpected expenses.
While she is receiving disbursements from an IRA, bonds, Social Security, and a survivor benefit, she says that if she has additional expenses, she prefers to draw from her reverse mortgage line of credit because she doesn’t have to pay taxes like she would if she took additional withdrawals from her IRA.
Pay Off Credit Card Debt
If you are heading into retirement with a large amount of credit card debt, a car loan, medical debt, or other consumer debt, a reverse mortgage can be used to pay these bills off. This is another way that a reverse mortgage could be used to free up cash in retirement.
If consumers seek debt relief, they typically have to pay taxes on the debt that is forgiven. This would not be the case if paid off with a reverse mortgage.
Pay for Home Renovations and Upgrades
Retirees could also use a reverse mortgage to make upgrades to their homes without having to tap into their retirement savings. Upgrades may be necessary to make the home more accessible, but it also allows older homeowners a way to make the home they already love feel like new without having to move.
In addition, upgrading the home will also increase the home’s value.
Financial planners have often preached that it’s best to diversify retirement portfolios to reduce risk for retirees. Accessing equity through a reverse mortgage is another way to do that.
Taking out a reverse mortgage is a serious decision. It is always recommended that you meet with your financial advisor and talk with your family to be sure that it’s the right decision for you.
One of the requirements for applying for a reverse mortgage is that you complete a counseling session with a third-party counselor approved by HUD to ensure that you understand the product and how it works. Your family members and financial planner are permitted to attend this session with you.
One difficult decision to make when pursuing a reverse mortgage is to choose a reputable lender to work with. If you don’t know where to start, check out our thorough reviews of the top reverse mortgage lenders as well as our top recommended lenders.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.