A close friend of mine requested I write a post on this topic. I hope you find this useful.
Let me construct a scenario for you. You are a few years away from retirement. Along with some modest savings, you also own your primary residence, which should be paid off by the time you retire. We can also assume that you will enjoy at least 30 years of post-retirement life.
Trying to live off your savings alone for the entire 30 years may prove challenging. This is because, contrary to what some believe, retirement can be quite expensive. For example, certain expenses such as medical and life insurance increase as you get older. As such, you will find that supplementing your savings pool will ease your retirement burdens.
One approach to supplementing your savings is by taking out a reverse mortgage. I’ve outlined below the concept of a reverse mortgage and my thoughts on its appropriateness as a retirement financing option.
What Is A Reverse Mortgage?
If a mortgage is a loan instrument that helps you purchase a home, a reverse mortgage is where your home helps you purchase additional debt. This type of debt can provide retirees with sufficient liquidity to manage their post-employment life. They can obtain this relatively easily, provided they own their property and that is free from liability.
There are certain characteristics that differentiate reverse mortgages from their traditional counterpart. For instance, borrower life expectancy influences the amount lent under reverse mortgages. Further, the interest rates on reverse mortgages are typically higher than home loans. At the time of researching for this post, the lowest rate I could find for reverse mortgages was 5.61%. This is considerably higher than fixed-term loans, which may range between 1.5 – 2.5%. This can add up quickly, given the compounding nature of this loan instrument.
Reverse mortgages have a built-in ‘ceiling’, which is equivalent to your property’s market value. Said differently, if the total reverse mortgage cost exceeds your home property value, you are not liable for the shortfall. Note that there are exceptions to this, namely the date at which you entered into the reverse mortgage.
A key benefit, at least from the retiree’s perspective, is that there’s no expectation to repay the reverse mortgage. This is because the loan will be ultimately settled by the beneficiary of the property. For example, if you bequeath your home to your child, they can sell the home to pay off the loan. However, as mentioned above, the higher interest rate can prove burdensome for the beneficiary, as it will eat into the home’s equity and the beneficiary’s inheritance.
My Thoughts on the Suitability of Reverse Mortgages For Retirees
Now I can take the analytical approach and compare the attributes of reverse mortgages against other loan instruments. However, instead, I’ll choose to evaluate reverse mortgages from an emotional perspective.
As a retiree and a parent, I’ve given considerable thought to what my wife and I can provide our son upon our passing. My considerations have not been limited to dollar value. I’ve also tried to evaluate the potential inconvenience it may cause him in managing his inheritance.
Allow me to explain. If we were to take out a reverse mortgage on our primary residence only, we will likely not require another cent for the rest of our lives. However, given current reverse mortgage rates, and the expectation that interest rates as a whole are anticipated to rise over the next few decades, our reverse mortgage will likely take a sizeable chunk from our home equity value.
While this may remain palatable for my son, he is still faced with the inconvenience of settling the mortgage upon our passing. This may prove quite inconvenient for him, given his decision to settle down in the United States. Therefore, our personal view is that we can forgo the additional benefit now so as to avoid detriment to our son in the future.
I say this knowing that there are many other parents like me that would share the same view. Reverse mortgages defer the financial burden to your beneficiaries, so you should be comfortable with them getting a small portion of your bequeathment. If this is not a concern, and your property will be passed on to charity, then a reverse mortgage may be an ideal retirement option for you.
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Reverse mortgages can provide an attractive financing alternatives for those retirees that lack a bolstered nest egg. However, depending on one’s personal circumstances and expectations around their estate, there may be other financing alternatives that may prove more appropriate. I will happily address these alternatives in subsequent posts.
The content outlined above was written, edited and published by the Lost Realtor. The author has over 20 years or real estate sales and investing experience in the Australian property market. He has held senior positions in Australian building companies, including being the General Manager of the residential sales division of Collier Homes. His qualifications include a Bachelor of Commerce degree and a Graduate Diploma in Building and Construction Law.