Robert C. Merton, a Nobel laureate in Economics who helped change the financial industry with his work on the “Black Scholes formula”, has now suggested a solution for how the world is going to address retirement - through a product called a reverse mortgage.
In his speech to a crowded room of financial experts, Merton stated “this is the greatest thing since sliced bread for retirees [yet] no one is doing it.”
Dr. Merton is clearly excited about this financial instrument, but why? Is this MIT professor exaggerating the benefits of a reverse mortgage? If he is actually right, why aren’t more people taking advantage of them?
Why Does Merton Have Faith In Reverse Mortgages?
His argument starts with a simple truth – people are living longer.
For simplicity, let’s imagine that fifty years ago the average American used to work for 40 years and then retire for 10 years. Fast forward to today, what happens if the average retirement lasts for 20 years instead?
- Scenario 1: 80% of the years go towards saving while 20% go towards spending.
- Scenario 2: 67% of the years go towards saving while 33% go towards spending.
While that can seem frightening, Dr. Merton is quick to remind us that longevity is a blessing if planned for appropriately, “all of this is basically good, it’s just a challenge.”
Essentially it is a balance between consumption (standard of living), years worked, and financial creativity. The question becomes what are Americans doing to address that last point?
How Do We Get More Out of the Assets We Have?
If you are like most Americans, your house is the most valuable asset you own. A reverse mortgage allows you to tap into the equity already invested in your home. Here’s how it works:
A lender will offer you a loan in the form of a lump sum, monthly payment, line of credit, or any combination thereof. This money is tax-free and can be used to make home improvements, pay medical bills, enjoy a vacation, or whatever else, so long as you pay your usual home-related expenses and do not allow the home to significantly deteriorate.
In exchange, the loan accrues interest which only becomes payable once you pass away, move, or sell the home. It is important to note that even if the loan grows to become larger than the value of the house, you will not be required to repay any additional loan balance in excess of the value of the home.
Here is the best part. When the loan comes due, the bank’s only form of recourse is through the house. That means your debt can’t be extended to your heirs, your income, or anything other than the home itself. Here are the most common scenarios:
What if the house is worth more than the outstanding loan amount?
Great! You can sell the house, pay off the loan, and keep the difference.
What if the house is worth less than the outstanding loan amount?
You can allow the bank to take ownership of the house and walk away with the money you’ve borrowed.
What if I pass away? Will the debt be transferred onto my kids?
No. Your heirs will walk through the decision to either pay back the loan or sell the house depending on their preference. If they want, they can let the bank take the house guaranteeing they won’t have to pay anything out of pocket.
What Should I Know Before Taking The Next Step?
If you need extra cash through retirement and want to stay in your home, a reverse mortgage can be a brilliant option. Before applying you will be required to go through an independent consultation to confirm that a reverse mortgage is suitable for your financial situation.
Here are some basic facts to keep in mind when considering a reverse mortgage:
- Reverse mortgages are FHA-insured loans
- You or your co-borrower (typically a spouse) needs to be age 62 or above
- You are borrowing against your home equity
- You do not need to repay the loan as long as one of the borrowers is still living in the home
- Reverse mortgages usually eliminate your ongoing mortgage payments
- You can choose to receive a monthly payment, lump sum, or line of credit to use against the house (or even a combination thereof)
- Reverse mortgages can be a welcome source of financial independence
- It's essential to comparison shop multiple lenders as offers can vary widely
Keep in mind that this product is not for everyone. For example, if you want to move within a few years, you should consider a traditional refinance instead. LendingTree encourages you to arm yourself with information before making any decision. Click here if you would like to learn more about how a reverse mortgage can provide tremendous financial relief, or click below to speak with lenders directly. Even if you have no intention of applying, knowing the offers available today can bring peace of mind if your circumstances change in the future.