Creative use of a reverse mortgage line of credit can make your retirement more secure. Recent scholarship suggests that opening a reverse mortgage line of credit and not using it until it is necessary, if at all, creates the most downside protection if you run short of retirement savings. This strategy allows the line of credit (the capacity) to grow longer which can then be used if retirement savings have been depleted (or nearly depleted). But of course there are some caveats discussed below.
Quick Review of a Reverse Mortgage
A prior post discussed that a reverse mortgage can be one way to enjoy your retirement if you plan on aging in place and not selling your home. Reverse mortgages are expensive due to the insurance premium you are required to pay.
The insurance premium covers the risk that the amount of the reverse mortgage exceeds the value of your home when the home is sold. You and your estate are not on the hook for being underwater, rather the bank is, if the home’s value is less than the reverse mortgage. To pay for this feature, all reverse mortgages have an insurance premium tacked on – a payment at closing and a monthly amount that is added to the outstanding reverse mortgage balance. Thus unless you are staying in your home until you pass, selling your home and paying off the reverse mortgage is an expensive proposition and reduces your sale proceeds.
So How Does the Reverse Mortgage Line of Credit Work?
A reverse mortgage line of credit provides you cash capacity if you choose to use it. This line of credit is similar to a regular home equity line of credit (HELOC). You can take out a reverse mortgage line of credit and rest assured that you have another source of funds if you need them.
Unlike a conventional HELOC, however, you don’t have to repay a reverse mortgage line of credit. Rather you only have to pay it back once you sell your home (or your estate sells your home).
This strategy works if you own your home outright. The reverse mortgage line of credit must be the first lien on the home. If you still owe a regular mortgage this strategy is less appealing because you’d have to pay off that mortgage (presumably using a reverse mortgage) and then take the line of credit.
But if you own your home outright, the costs to getting a reverse mortgage line of credit are rather low if you get the it sooner (or right after age 62) than later.
Why do you ask? The key here is the initial line of credit grows each year as age. This is a unique feature of the federal reverse mortgage program. The line of credit will grow automatically at a variable rate that considers current interest rates and the borrower’s initial age. The closing costs, however, are applied only at the closing. So you can pay minimal closing costs and have a reverse mortgage line of credit that continues to grow beyond the initial amount of the line of credit.
If you were to sell your home during your lifetime and you hadn’t tapped the reverse mortgage line of credit, it is as if it weren’t there. There is nothing to pay back.
So you can buy a protection at an earlier age and then reserve using it until it is needed, if ever. It can provide peace of mind for those who already own their home but are fearful of running out of money during their lifetime.
What are the Upfront Costs for a Reverse Mortgage Line of Credit?
When you open a reverse mortgage line of credit, the fees include a 0.5% upfront mortgage insurance payment premium (e.g., this percentage is applied to the total amount of the initial line of credit), typical loan origination fees, and other closing and settlement costs. You can shop around among lenders to find the lowest costs.
The biggest charge is the 0.5% mortgage insurance premium on the line of credit. But this can be a small amount if you get the line of credit soon after turning age 62 and the line of credit (capacity) grows as you grow older as noted above.
In sum, you may want to consider opening a reverse mortgage line of credit soon after turing age 62 (to lower the closing costs) and allow the limit to grow automatically to safeguard against running out of savings. This strategy works if you don’t have a mortgage but are worried about outliving your assets.