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Everyone has seen how housing prices have taken a nosedive in most markets across America since the start of the 2008 recession. Almost $3 trillion worth of equity has disappeared, and homes are now worth significantly less than what their owners paid for them. This evaporation of equity has dealt a devastating blow to many elderly Americans who were originally planning on tapping into that equity to supplement their retirement through reverse mortgages.
The truth is that reverse mortgages shouldn’t be used as a last minute tool to fund your retirement. Unfortunately, the lack of homeowners’ equity and a host of other factors have made reverse mortgages a thing of the past as a retirement option.
What is a reverse mortgage?
A reverse mortgage is much like a standard mortgage for your home. It is called a reverse mortgage because the homeowner will receive a cash payment based on the amount of equity he or she has in their home. So, after you finally get your home mortgage paid off and you own your home free and clear, you can go back into debt again for the exact same house with a reverse mortgage.
In contrast to a conventional mortgage, however, there is no repayment requirement as long as the homeowner meets certain requirements, such as continuing to use the home as his or her primary residence. Once the borrower dies, the loan must be repaid.
Reverse mortgages require equity
One of the biggest realizations to come out of the current housing crisis is that reverse mortgages require homeowners to have equity in their homes. If you’ve been banking on a reverse mortgage to fund your retirement instead of investing for your financial goals that you should be been doing all long, you could be in for a rude awakening if the equity in your home has vanished.
This is exactly what happened during the recent (and ongoing) housing crisis, and many Baby Boomers and retirees have been left in a tough situation with little in the way of retirement savings and a hope of using home equity and a reverse mortgage to fund their retirement dreams. But, when the equity disappeared, so did their ability to borrow against their home for retirement. Traditionally, homeowners thought that home prices would rise forever, but that has proven not to be the case in recent years.
Reverse mortgages can hurt your heirs
When you borrow against your home equity to cover living expenses in retirement, you’re putting your heirs at risk of some serious estate planning consequences. When you die, your reverse mortgage must be repaid. Many estates do this either with insurance proceeds or by selling the primary home that was mortgaged. This can be devastating news to family members who may have been counting on those funds for one reason or another — e.g., daily living expenses, paying for a future college education, or paying off other debts of the deceased. Reverse mortgages also have the potential to forcing the sale of homes that have been in families for generations.
Reverse mortgages aren’t a substitute investing
When home prices in America were skyrocketing, many people skipped funding their retirement accounts in favor of buying a bigger home and paying down their mortgage. The trouble with this is that you really need to have a well-rounded financial plan that includes investing for retirement and other goals, saving, paying down debts, and protecting yourself and your family with insurance. Banking on the ability to borrow against the equity in your home during your retirement years is a very risky strategy that can blow up in your face.
Reverse mortgages are expensive
Historically, reverse mortgage are very expensive because of very high fees. These fees erode the value of what little equity you have built up in your home. Like all home loans, there is an origination fee, appraisal fees, closing costs, insurance, and a host of other fees that are tacked onto your reverse mortgage. Because of this plethora of fees, the cash payout that you receive in this depressed housing market will be even further reduced.
In the final analysis, there’s no better alternative to investing for retirement than a well-balanced portfolio of stocks, bonds, and/or mutual funds. Using your home as a way to fund your retirement dreams is fraught with potential drawbacks, and the expectation that you’ll have a ton of equity at retirement is based on the faulty assumption that your home will necessarily increase in value, or at least retain its current value.
Do you have any experience with reverse mortgages? Has your declining home value now made a reverse mortgage impossible? I’d love to hear your thoughts in the comments section.