When parents are concerned they can’t save for their child’s college education and for retirement, experts will often tell them to think of their needs first.
There is a financial product that does allow seniors to borrow for retirement. If seniors have substantial equity in their homes, they can take out what is called a reverse mortgage.
Unlike a traditional mortgage, with this loan product, you don’t have to make monthly payments. Reverse mortgage borrowers don’t pay back their loans until they move, sell or die. Once the home is sold, any equity that remains after the loan is repaid is distributed to the person’s estate.
There are many folks who have most of their wealth tied up in their homes, which is often referred to as being “house rich, cash poor.” A reverse mortgage gives people another way to get at the equity in their homes.
Typically, homeowners who want to access equity they’ve built up have to sell their home or take out a home-equity loan or line of credit. But selling isn’t an option if they want to stay put, and they would have to make payments on the line of credit or the loan. Given those options, a reverse mortgage can seem very appealing.
To qualify for a reverse mortgage, you have to be 62 or older. You have to have paid off your mortgage or paid down a considerable amount so that you have equity to tap. Your home must be your principal residence. Most importantly, borrowers have to maintain the home and pay property taxes and homeowners insurance.
Borrowers can take the reverse mortgage loan as a line of credit, a lump-sum payment, fixed monthly payments or a combination. The loan size depends on the borrower’s age and other factors.
An overwhelming majority of borrowers get a reverse mortgage through the Federal Housing Administration’s Home Equity Conversion Mortgage (HECM) program. Reverse mortgages through this program are insured by the federal government and are available through FHA-approved lenders. FHA requires all HECM borrowers get housing counseling.
A February paper by researchers at the Center for Retirement Research at Boston College looked at whether a reverse mortgage is worth it for older homeowners who need money and have equity in their homes.
“For many households, particularly those with less wealth, their home equity is larger than their financial assets,” the researchers wrote. “Tapping home equity in retirement could provide millions of retirees with a way to make ends meet or to maintain their standard of living.”
But people have to consider the cost of a reverse mortgage. A HECM loan on a $300,000 house costs about $13,500 up front and 5 percent on amounts borrowed in January 2020, with the rate adjusted annually, according to the paper.
Given higher upfront cost, a reverse mortgage works best if you plan to stay in your home for a long time.
The vast majority of households rarely change residences, even over several decades. “Households either stay in the home they were in during their 50s, or they buy a new home around retirement, where they generally remain for the duration,” the researchers found.
The researchers concluded that for many older homeowners — with the exception of people who frequently move — tapping home equity through a reverse mortgage could be a good financial strategy. In essence, they can borrow for retirement.
Still, this financial product may not be appropriate for you. Here are some issues to think about before taking out a reverse mortgage.
— Understand the rules involving a non-borrowing spouse. An older spouse will often take out a reverse mortgage in his or her name only, because older homeowners can borrow against a greater percentage of the home’s equity. Under certain conditions, some spouses may be able to stay, but others may not be able to hold on to the home.
— Be sure you can maintain the property. Many seniors faced foreclosure after taking out reverse mortgages, either because they fell behind on property charges or failed to meet other requirements of the complex mortgage loans, according to a 2017 report in The Washington Post. A 2012 report from the Consumer Financial Protection Bureau found a large proportion of borrowers — nearly 10 percent — in the federally insured HECM program were at risk of foreclosure because they had not paid their property taxes and insurance.
— If you have adult children or other relatives living in the house, be sure they understand what could happen if the reverse mortgage becomes due.
— Be careful about draining your home equity. I’m concerned that some seniors will use the money from a reverse mortgage not to supplement other income or to make needed home improvements, but instead as a pot of money that they will too quickly deplete.
The Department of Housing and Urban Development has a lot of fact sheets about reverse mortgages, including ones on the rights of non-borrowing spouses and people who inherit homes with this type of mortgage.
There are pros to a reverse mortgage, but the complexity of the product means you shouldn’t overlook the cons.
Reader Question of the Week
If you have a retirement question, send it to email@example.com. In the subject line, put “Question of the Week.”
Q: My question concerns the penalty that you have to pay if you don’t enroll in Medicare Part B when you are first eligible. The medicare.gov website states: “If you didn’t get Part B when you’re first eligible, your monthly payment may go up 10% for each 12-month period you could’ve had Part B, but didn’t sign up.” What is the 10 percent penalty based on?
A: People newly eligible for Medicare can join the program during an “initial enrollment period” beginning three months before their 65th birthday and ending three months after the month they turn 65. Part B covers physicians’ services and other forms of outpatient care. It’s important to understand that if you do not sign up in your initial enrollment period or when your job-based coverage ends, you will pay a penalty that will increase your premiums for Medicare Part B for the rest of your life. Every year you delay signing up for Part B, your monthly premium rises by 10 percent.
Following is how the late penalty would be applied, according to an example from medicareinteractive.org: You turned 65 in 2013 but didn’t sign up for Part B until 2020 (and you did not have employer insurance, which allows you to delay enrollment). Your monthly premium would be 70 percent higher for as long as you have Medicare (7 years x 10 percent). Because the base Part B premium in 2020 is $144.60, your monthly premium including the penalty will be $245.82.
Medicareinteractive.org also points out that although your Part B premium amount is based on your income, the penalty for signing up late is calculated using the base Part B premium.
Please join me on Thursday, Feb. 27, at noon (Eastern time) for a live discussion about your money.
My guest will be Sean Martin. He will be taking your questions about “Homefile: Financial Planning Organizer” by certified financial planners J. Michael Martin and his wife, Mary E. Martin, who died in 2007. I first reviewed their filing system 15 years ago. Sean and his brother have worked on keeping the “Homefile” organizer going in their mother’s honor. I recommended the latest version for the Color of Money Book Club for this month. It’s available only at homefile.net.
I wrote about the “Homefile” system last week.
Retirement Rants and Raves
Your thoughts: Have you taken out a reverse mortgage? If so, what has been your experience with this loan product? Send your comments to firstname.lastname@example.org. Please include your name, city and state.
I’m also interested in your experiences or concerns about retirement or aging. You can rant or rave. In the subject line, put “Retirement Rants and Raves.”
In a recent newsletter, I discussed paying off debt vs. retirement savings. I asked readers their thoughts on this dilemma.
“I know your advice is sound, but I’m skeptical that people will actually put the money to their debt if they quit contributing to the 401(k),” one reader wrote. “If you are undisciplined, as I was for too long, the 401(k) is a very good way to save while it’s very hard to pay off debts with money that comes home. Maybe they should consider going to their credit unions for a consolidation loan at a much lower rate then a credit card. Then, the debt payments could come right out of the paycheck. So the issue of discipline would go away a little bit. This is what I did when I was younger and ran up some credit card debt.”
“I would disagree with you on the idea of people pulling back on retirement savings to pay off debt,” wrote Gary Roth of Emlenton, Pa. “In the best of all possible worlds, that would be a good solution — to put off retirement savings to pay off high-interest debt, then making it up when the debt is cleared. But that isn’t what happens for most people — the retirement income is never made up, and it is that which is put in early, that makes the most difference when it comes to retirement. The other factor is the psychological one. A person needs to regard their retirement income as not being ‘spendable.’ In other words, it is never in play in their budget. A person who is carrying large amounts of debt on credit cards, needs to get that under control, and learn to live within their budget — not rob themselves of their future to make the pain of living above what they can afford more bearable.”
Ellen Campbell of Montclair, N.J., weighed in on the debate about the recent rule change concerning inherited IRAs.
“I have to say, I find it absolutely mind-boggling that people are outraged that they have to take money out of their retirement accounts, or they are angry at the new rule that an inherited retirement account must be drawn down to zero by the end of year 10,” she wrote. “They seem to blame the ‘government’ for these rules, when the government was the one that gave them the substantial tax break when they funded these accounts. Either it demonstrates ignorance about these accounts, or I (or my heirs) just want to have my cake and eat it, too. I think the new 10-year rule is completely reasonable.”
In a previous newsletter, one reader wrote: “My children will both be of age by 2025, so potentially, if I’m no longer living, the government will be forcing them to spend my hard-earned retirement funds during their college years. The children also won’t be eligible for loans/scholarships because they will both be paying taxes on the IRA earnings.”
Sherman Lieberman of Foster City, Calif., also responded to the criticism about how the Secure Act will change people’s plans for leaving money to their children. He wrote: “Two things here. The government never forces you to spend an RMD. This is a common misconception among many of my friends. The government only forces you to withdraw the money from your tax-advantaged account and pay taxes on the amount as ordinary income. Nothing prevents you from reinvesting or transferring the funds to another investment or bank account and continue to save.” Lieberman added: “My understanding of the Secure Act is that the retirement account for non-spouse beneficiaries now has to be paid out within 10 years, not necessarily over 10 years. The entire amount could be withdrawn in the 10th year without penalty. So in [the reader’s example], his children could time the payout so as not to coincide with their college years and not have the income disqualify them from loans/scholarships.”