Reverse mortgages can be a financial lifesaver for retirees, as long as they are handled with care.
The lure of a reverse mortgage can be hard to resist. What could go wrong with drawing a monthly income from home equity as long as you don't move? Unfortunately, a financial misstep or unforeseen circumstances could leave a homeowner with a reverse mortgage in financial ruin.
In recent years, the federal government has enacted rules to better ensure that reverse mortgages are a safe product and that possible defaults are warded off. Combined with personal discretion and a little know-how, a reverse mortgage can be a smart choice for some retirees.
Here's what you need to know to decide whether a reverse mortgage is a safe choice for you.
Government Rules Make Reverse Mortgages Safer
The U.S. government has enacted several reverse mortgage consumer protections since 2013.
1. Caps on first-year borrowing
Since 2014, government rules have limited most borrowers to generally withdrawing no more than 60 percent of their reverse mortgage loan in the first year.
2. More protection for spouses
In worst-case scenarios, a surviving husband or wife can lose the house if his or her name is not listed as a borrower when the spouse dies. HUD rules implemented in 2014 and 2015 could potentially allow a surviving "non-borrowing" spouse to continue living in a residence full time as long as he or she makes timely tax and insurance payments.
3. Tighter financial checks
After reverse mortgages hit the market in 1987, for many years almost anyone with enough home equity could qualify. Now, lenders have to examine everything from a potential borrower's credit history to her cash flow before issuing a reverse mortgage.
Personal Safeguards Keep Reverse Mortgage Spending in Check
Once you've qualified for a reverse mortgage, making wise financial decisions with the income will ensure that this financial tool helps you over the long run.
1. Time it right
A reverse mortgage should be a financial supplement, not your primary retirement income. If you are thinking about taking out a reverse mortgage in your early sixties, you'll need to look at how it will factor into your financial situation for possibly two or three more decades.
It's smarter to base your retirement on a pension, savings, or other income sources rather than a reverse mortgage. Consider a reverse mortgage only at the point in life when you'll need the extra money.
2. Set up a monthly payment
While taking out a reverse mortgage in a lump sum is tempting, consider whether you're disciplined enough to portion out the money over time. A better choice would be setting up monthly payments to yourself, which will provide slow and steady income and make your equity last longer.
3. Draw on it only for emergencies
A standby line of credit from your reverse mortgage will make the money available only for emergencies, such as an unexpected medical issue. Otherwise, it's left alone until you need it.
4. Use it to bolster your investments
If you are drawing retirement from investments, a market downturn could decrease your monthly income. In this case, you could borrow money in a reverse mortgage line of credit until the market recovered, and then pay yourself back.
Another option would be to take income from a reverse mortgage to delay drawing Social Security, which would result in a higher lifetime benefit payment when you do apply for it.
Thanks to government regulations and smart strategies, reverse mortgages are no longer considered a financial disaster waiting to happen. For retirees who are concerned they will run out of money, a reverse mortgage used wisely can provide much-needed income.