Could a reverse mortgage prolong retirement savings? Here's how this loan can help seniors and retirees living on fixed income hedge against inflation.
*This article does not constitute tax or financial advice. Please consult a tax and/or financial advisor regarding your specific situation.
Inflation is driving up the price of everything from Chipotle burritos to Oreo cookies, but the effects are being felt far beyond the grocery aisle — particularly for retirees.
CNBC reported that many retirees are worried about inflation tanking their retirement savings, and leaving them with too little money to live on in the coming years.
It’s a valid concern.
“We’ve never had interest rates on income this low in history, so now the amount of money [retirees] can get in their savings is the lowest that it’s ever been,” says Harlan Accola, author of “Home Equity and Reverse Mortgages: The Cinderella of the Baby Boom Retirement.” “So not only did most Baby Boomers not save enough, now in addition they’re not getting enough guaranteed income on their savings, so it’s the lowest return on investment in decades.”
That creates a compounding problem for retirees, Accola said.
“Although the stock market is doing well today and it’s easy to take income from the gains, it’s volatile — and what goes up can go down,” he said.
In retirement, seniors will need to draw on their stock market funds to supplement their Social Security benefits as prices rise, according to Accola. If the market loses money and seniors draw out money in a declining market, this dramatically increases the chance that they will not have enough savings to see them through retirement.
‘A double whammy’
“Retirees are dealing with a high rate of inflation and low interest rate, so it’s a double whammy,” Accola said. “It has increased their costs on everything from eggs to gas in the car. But their income is not going up. Social Security, even with inflation, might only go up 6% this year.”
For a retired couple that receives $2,400 a month in total from Social Security, that would be an increase in benefits of just $144, according to Accola.
“What does that do?” he said.
The pinch of inflation today can create financial crises for seniors down the road.
In the short-term, retirees living on fixed incomes are faced with quality of life choices based on how much their budgets can handle.
They might be less inclined to dine out due to price increases, anxious that eating at a restaurant will mean they’re short on their bills. Even trips to visit family could become less feasible, as they’ll have to consider whether they can afford the cost of gas for a road trip or airline tickets.
Further out, though, price hikes on day-to-day necessities such as groceries and gas will take up more of their savings and put them in a much more difficult position for big expenses.
“What happens when they have to replace their car? What about healthcare? What’s it going to cost them with the deductible in the hospital?” Accola said. “It’s the little things that are chipping away, with the gas and the eggs and the food that’s going up. And then of course, the great big thing is going to be a horrible shock.”
But for those who own their homes, there may be an antidote: a reverse mortgage.
With home values soaring since the start of the Covid-19 pandemic, senior homeowners have an opportunity to tap their home equity and significantly increase their cash on hand each month.
“The high housing prices is the lifeline that counteracts what they’re losing,” Accola said. “So while inflation is bad with the regular spending, it’s wonderful if they own a house.”
What is a reverse mortgage — and how can it help save your retirement savings?
Reverse mortgages allow homeowners who are 62 and older to borrow against the equity in their homes without making monthly mortgage payments, provided they continue paying property taxes, homeowners insurance, and upkeep expenses.
Unlike standard “forward” mortgages, a reverse loan gives borrowers the option to receive monthly cash advances or access to a line of credit (or a combination of the two).
Borrowers can make monthly payments, but they don’t have to, as long as they keep their taxes, insurance, and maintenance current. The loan comes due when the last borrower, or designated non-borrowing spouse, dies or leaves the home.
A reverse mortgage helps retirees with inflation on a few fronts.
Monthly cash advances provide retirees a much-needed supplement to Social Security income and other government benefits. A borrower who wants to leave money in their investment or retirement savings accounts may be able to delay withdrawals when the market goes down by relying on reverse mortgage proceeds instead. Of course, each homeowner’s circumstances will be different, and they should discuss any retirement planning strategies with their financial advisors.
But using reverse mortgage funds is particularly advantageous in years when the market is down, said Accola and Dan Hultquist, author of Understanding Reverse: Simplifying the Reverse Mortgage. Rather than take money out of investments when the market is low, homeowners can leave it in and take money out of their home instead. That gives their portfolio a chance to grow as the market rebounds*, and they still have enough money for day-to-day and emergency needs.
A borrower who wants to leave money in their investment or retirement savings accounts may be able to delay withdrawals when the market goes down by relying on reverse mortgage proceeds instead.
Is reverse mortgage income taxable?
Importantly, cash received from a reverse mortgage does not count as taxable income* — unlike investment gains, which are taxable. Retirees can use money from a reverse mortgage without worrying that it will put them in a higher tax bracket and increase their tax burden.*
Reverse mortgages are worth a look even for empty-nesters who assume their retirement savings and benefits are sufficient because they’re no longer supporting their children. Inflation affects everyone, and retirees may feel compelled to step in even if their own kids are fully grown.
“There are some things they think they don’t need to worry about, like college education. But now you’ve got grandkids that can’t afford to go to college,” said Hultquist. “Do seniors then access some of their wealth to pay for college education? Yeah. And they don’t want to disrupt their traditional retirement plan. So inflation actually hits them on things that you wouldn’t think that they would get hit with.”
Drawing on the equity in their homes enables retirees to help their families navigate the effects of inflation without depleting their nest eggs.
Waiting to see if housing prices rise? That’s a bad bet.
With housing prices rising in markets across the country, retirees might think they’re better off waiting until next year to take out a reverse mortgage in case their homes increase in value. A higher age allows you to qualify for a bigger loan, so holding out another year or so may seem like the obvious move.
But waiting is a mistake, Hultquist says. Yes, home values could continue to rise — but so could interest rates. And interest rates substantially affect whether a borrower qualifies for a reverse mortgage and how much they receive.
Let’s say a borrower is 69 today, and they qualify for a reverse mortgage at 3.25% interest. Maybe their principal limit — the amount of equity they can access — is 56.6%.
The borrower decides to wait a few years, with the expectation that their principal limit will increase as they get older.
Now they’re 72. If interest rates stayed the same, they might have a principal limit of 57.2% — a modest increase from what they were eligible for three years earlier.
But if interest rates increased, it’s a very different story. Perhaps the borrower receives a 4% interest rate. Now their principal limit drops to 52.4%, a 4.2% loss from what they could have had at 69.
“You’re waiting three years to get an extra 0.6%,” Hultquist says. “But what could happen in those three years? Rates could go from three and a quarter to 4%. You wind up losing 4.2%. That’s huge.”
Note that these numbers are just examples — the rate any individual borrower receives will depend on their financial profiles, equity, interest rates at the time of borrowing, and other factors.
Hultquist also notes that putting off the reverse mortgage decision limits your line-of-credit (LOC) growth. “The LOC growth is maximized by obtaining the reverse mortgage early and letting time do its work,” he says.
The longer the line is open, the more chance it has to grow.
If the home value increases and interest rates drop — an unlikely scenario because rates are already so low, according to Accola — borrowers can refinance the reverse mortgage.
Waiting to take out a reverse mortgage can also decrease a borrower’s chances of qualifying. A couple that currently receives $2,400 in Social Security income might qualify jointly, depending on their age and amount of equity in the home.
But if one of them passes away, the other’s income will drop to $1,200 per month. Lenders conduct financial assessments before approving homeowners for reverse mortgages to ensure they can afford the property taxes, insurance, and upkeep on the home, on top of any other debts and obligations.
A borrower who receives just $1,200 a month may not have sufficient income to cover all of their expenses and could be denied a reverse mortgage loan.
The bottom line about retirement savings
Some experts say current inflation trends are transitory and not cause for long-term concern. But for retirees who are worried about making ends meet, and about being able to meet their lifestyle and healthcare needs, that may seem like cold comfort.
A reverse mortgage can provide flexibility and relief as seniors and their advisors determine the best strategies for making their savings last as long as needed in retirement.
Copyright©2021 Fairway Independent Mortgage Corporation (“Fairway”) NMLS#2289. 4750 S. Biltmore Lane, Madison, WI 53718, 1-866-912-4800. All rights reserved. Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA and were not approved by HUD or a government agency. Reverse mortgage borrowers are required to obtain an eligibility certificate by receiving counseling sessions with a HUD-approved agency. Youngest borrower must be at least 62 years old. Your monthly reverse mortgage advances may affect your eligibility for some other programs. At the conclusion of the term of the reverse mortgage loan contract, some or all of the equity in the property that is the subject of the reverse mortgage no longer belongs to you, and you may need to sell or transfer the property to repay the proceeds of the reverse mortgage with interest from your assets. We will charge an origination fee, a mortgage insurance premium, closing costs or servicing fees for the reverse mortgage, all or any of which we will add to the balance of the reverse mortgage loan. The balance of the reverse mortgage loan grows over time, and interest will be charged on the outstanding loan balance. You retain title to the property that is the subject of the reverse mortgage until you sell or transfer the property, and you are therefore responsible for paying property taxes, insurance, maintenance and related taxes. Failing to pay these amounts may cause the reverse mortgage loan to become due immediately and may subject the property to a tax lien or other encumbrance or to possible foreclosure. Interest on reverse mortgage is not deductible to your income tax return until you repay all or part of the reverse mortgage loan. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.