While there are many elderly homeowners using reverse mortgages to help shore up their financial positions, the growth in this relatively new tool is coming increasingly from people taking a sophisticated look at their financial positions.
People are using reverse mortgages to hedge against market risk, minimize estate tax liability and protect their assets from a costly long-term illness.
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So while there are many equity-rich, cash-squeezed seniors taking out reverse mortgages, they are part of a varied and increasingly sophisticated group.
As a result, more and more financial planners and CPAs are incorporating reverse mortgages into their wealth management recommendations.
Since 1990, more than 300,000 seniors have used the U.S. Department of Housing and Urban Development’s federally insured Home Equity Conversion Mortgage (HECM) to convert the equity in their homes into cash without having to move. And between 2000 and 2006 alone, there has been more than a 10-fold increase in the number of reverse mortgages backed by the Federal Housing Authority.
In fact, by mid-June 2007, the FHA had already backed 69,833 loans, putting the HUD’s HECM program on pace to surpass its 2006 total before the summer was over.
The appeal of the reverse mortgage is simple. As people retire, they want to be financially secure and independent.
With a reverse mortgage, homeowners can turn the value of their home into cash without having to move or repay a loan each month. They can receive the cash as a single lump sum, as a regular monthly advance or as a credit line. No matter how the loan is paid out, homeowners do not have to pay anything back until they die, sell their home or permanently move out. To be eligible, homeowners must be 62 years of age or older.
Reverse mortgages have been around since the 1950s, but only recently have caught on as a financial planning tool.
This is due to misconseptions, such as that the lender takes possession of the home once the reverse mortgage comes due. Another myth is that in a declining real estate market, homeowners or their heirs could end up owing more than their house is worth. Neither is true.
The loan repayment can never exceed the value of the home when it is sold, and if there is a surplus, it all goes to the person’s heirs or estate.
Financial advisers are now recommending reverse mortgages as a way to shield investment portfolios from market volatility, long-term care expenses, and estate taxes.
One strategy is to use the reverse mortgage as a hedge against market risk. Consider a 70-year-old widow who supplements her retirement income with 4 percent from her investments each year. In a significant market downturn, taking the same amount of money may now represent 6 to 7 percent of her portfolio. By setting up a reverse mortgage as a line of credit, she can draw the annual supplemental income that she needs from the line rather than from her investments, allowing her portfolio to recover. Once it has, she can discontinue drawing from the line and resume payments from her investments.
The reverse mortgage will enable her to reduce the risk of outliving her investment portfolio, maintain her standard of living, and actually increase her net worth.
A second example: A senior couple with a $400,000 home and an $800,000 investment portfolio is concerned about future estate tax liabilities for their heirs. Employing a reverse mortgage to fund a life insurance trust ensures that they will be able to provide their heirs with an inheritance tax-free. Similarly, a reverse mortgage can pay the premiums on a shared long-term care policy, reducing the risk that a serious illness poses to a couple’s estate while helping to maximize its potential value.
One reason that such strategies are necessary is that retirees today face unique financial challenges such as:
• Financing extended lifetimes.
• Having minimal or no defined pension plan.
• Paying rising medical costs.
• Being unsure about the solvency of Social Security.
The good news is, financial advisers are finding new strategies that can help their clients address these issues. As a tool in the adviser’s arsenal, reverse mortgages are becoming an increasingly common method to maintain or enhance clients’ quality of life while minimizing financial risk. •
Brenda Archambault is a reverse mortgage specialist at The Washington Trust Co. For more information, call 782-1000, ext. 6125.
