Traditionally, advisors have tried reduce or eliminate clients’ debts by the time retirement is upon them. But while there is clearly a difference between the types of debt to which a retiree might be subject, there is often no distinction made between these various debts in pursuit of this goal. Instead, there is just a simple, focused effort on “getting rid of debt” before retirement.
With so many clients focused on what has become an almost universal goal — and not without reason — it would seem almost blasphemous to suggest a client go the opposite route and take on more debt in retirement. That, however, may not be as crazy an idea as it sounds, particularly with respect to reverse mortgages.
Related: 7 ways retirees can make money
Reverse mortgages, which at one point were expensive and viewed as the Wild West of loans, have come a long way in recent years, thanks to increased regulation and consumer scrutiny. Whereas in the past such loans were really only beneficial as an option of last resort, today they can be valuable tools in a variety of situations and can aid in making sure clients meet their retirement goals.
Reverse loans are available in a variety of forms, including as a:
Line of credit (increases over time)
Term payment (similar to period-certain annuity)
Tenure payment (similar to life annuity)
Combination loan (two or more of the above options); and
Of all of the above options, the line of credit reverse mortgage could be the most valuable in terms of planning opportunities today. Such loans can be used to great effect in a variety of ways. For instance, in the event of a significant market correction that leads to a substantial decrease in portfolio assets, using a reverse mortgage line of credit can help clients meet their income needs while avoiding tapping their portfolio at an inopportune time in the market cycle.
Such loans can also help meet significant expenses, such as long-term care costs, in the event a client does not have adequate coverage otherwise. Today’s low-rate environment only amplifies the benefits of this planning option.
Whereas in the past reverse mortgages were only beneficial as a last resort, today they can be valuable tools in a variety of situations and can aid in ensuring clients meet their retirement goals. (Photo: Thinkstock)
7 attributes of reverse mortgages
While the reverse mortgage strategy won’t be right for everyone, advisors should be aware of the basic rules and principles so that they can determine if it’s an approach worth exploring. Key aspects of the reverse mortgage line of credit include:
Borrowers must be at least 62
The borrower must own the home outright or repay existing loans with reverse mortgage proceeds
The loan is not required to be paid back until the borrower dies, sells or otherwise vacates the home (certain spousal protections also exist)
The loan is a non-recourse loan (the only collateral is the home)
The borrower is responsible for all upkeep on the property, including HOA fees, insurance and property taxes
Loan proceeds are non-taxable; and
Interest accrues only on borrowed amounts
So what does it cost to establish a reverse mortgage? It depends on how the loan is set up. In many situations, up-front mortgage insurance premiums today are just 20 percent of what they were in the past. Closing costs can be a significant expense similar to traditional mortgages, but may be rolled into the mortgage. As with traditional loans, clients would be best advised to obtain quotes from multiple sources.
For clients uninterested in reverse mortgages, but who like the idea of being able to tap home equity to avoid dipping into portfolio assets during a correction, home equity lines of credit (HELOCs) can be an alternative approach. However, clients should be aware that qualifications for such loans may be more stringent and, perhaps more importantly, HELOCs can be frozen, reduced or cancelled, but reverse mortgage cannot.
For many advisors, there’s an additional concern when discussing reverse mortgages: compliance. Unfortunately, this is one area where the math, the planning and the logical option may not align with industry regulations or company policies. Simply put, advisors need to know the limitations that apply to them and must stay within those boundaries.
For those advisors with the flexibility to be able to discuss such matters though, strong consideration should be given to exploring reverse mortgages for clients, especially during the current low interest rate environment. The younger a client secures a reverse mortgage and the lower the interest rate, the greater the long-term benefit of the reverse mortgage.
When discussing such matters with clients, advisors should be prepared to encounter resistance due to the widely held negative views of reverse mortgages, which many clients are likely to share. Be prepared to discuss what changes have occurred and why today’s reverse mortgages are not like those of the past.
And keep in mind that, with respect to the HELOC-like reverse mortgages discussed above, the younger a client, and the lower the interest rate, the more such a strategy may make sense. To that end, if you have a client in their early 60s today, you have to ask yourself, “When will there ever be a better time?”
Bottom line: Like most everything else, this strategy won’t make sense for everyone, but using reverse mortgages as portfolio buffers and emergency reserve funds instead of as the traditional retirement income replacement vehicle can make a lot of sense. Doing so will help ensure that interest expenses are kept to a minimum, but also protect against portfolio assets eroding prematurely because of poor timing.
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