Essentials of Reverse Mortgages

Reverse mortgages have been both touted as a solution for older homeowners who are struggling financially and criticized for the fees associated with them. Both observations carry some truth. But reverse mortgages can play a role in the financial plans of seniors who are relatively well off.

How it Works

Reverse mortgages allow homeowners age 62 or older to convert some of the equity in their homes into cash. The payments, which typically are tax-free and unlikely to affect Social Security or Medicare benefits, are repaid only when the last borrower passes away or sells or leaves the home. However, because the homeowners retain title to the home, they remain responsible for taxes, upkeep and other expenses.

While reverse mortgages are one way to free up cash that otherwise would remain tied up in a house, they’re not right for everyone. And because reverse mortgages carry origination, servicing and other fees, they may not be the best solution for homeowners who plan to remain in their house for just a few years. In this case, a home equity line of credit may be a better alternative.

Why They Might Make Sense

Research suggests that reverse mortgages may make financial sense even for some homeowners who aren’t struggling to pay the bills. A 2012 study in the Journal of Financial Planning examined the financial impact of three strategies an individual might use to generate income. They include:

1) Exhausting a securities portfolio and then turning to a reverse mortgage,

2) Using the proceeds from a reverse mortgage while simultaneously taking cash from an investment portfolio, and

3) Drawing on the reverse mortgage credit line first.

Researchers found that the second and third options can, in many cases, increase the “cash flow survival probability” over a 30-year period. The reason for this counterintuitive conclusion? The investment portfolio continues to grow while the individual is drawing down the reverse mortgage.

Still another strategy that homeowners might benefit from is to use a reverse mortgage to delay the start of Social Security benefits.

Next Steps

If a reverse mortgage appeals to you, make sure you thoroughly run the numbers. Reverse mortgages are complicated financial instruments. And while they can be a sensible option for some homeowners, making the determination requires an honest assessment of one’s financial situation and the pros and cons of reverse mortgages.

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