By: Jeff Deiss, CFP
Q. I’m on a fixed income and expenses are tight, but my home is valuable and I’m wondering if there is a way to use it to help with my living expenses?
A. You have several options to consider in using the equity in your home for expenses. There are advantages and disadvantages to each so you should tread lightly and educate yourself first before making a decision.
Downsizing: One frequently used option is simply to downsize by selling your existing home and either buying a smaller home or renting to help lower your living expenses by eliminating costs such as upkeep and property taxes. Any net sale proceeds can be kept on hand for current living expenses or invested for future expenses.
The sale of an existing residence typically accompanies a decision to transition to a Life Care Community (Continuing Care Retirement Community) where stages of independent, assisted living and skilled nursing care are all available as we get older.
The thought of moving, cleaning out our house and enduring the process of selling our home can be daunting for many. We know as we’ve helped several of our clients through this process! For those of us who don’t want to move, then there are other options to tap the equity in our home to fund living expenses.
Home Equity Loans: Common considerations are either a home equity loan, a home equity line of credit, or a reverse mortgage, all of which allow you to borrow against the equity in your home .
Both a home equity loan and a home equity line of credit are “second mortgages”, for which you have to qualify and where borrowers must make monthly payments on the principal and interest over time. Having to make loan payments may or may not solve your problem, particularly if interest rates go up and increase your payments, and a tight budget may prevent you from qualifying in the first place. Tread lightly before choosing either of these options, and be sure to discuss the implications with your wealth advisor so you can educated on the potential up-front and ongoing costs over time.
Reverse Mortgage: Another consideration, which historically has had a sketchy reputation and is now becoming more and more mainstream, is a reverse mortgage.
Reverse mortgages are similar to home equity loans and home equity lines of credit in that you can turn some of the equity in your home into cash for living expenses. You can receive payments either as a lump-sum upfront, in equal monthly payments over time, or simply in an amount that you need, when you need it, over time. The primary difference between a reverse mortgage and a HELOC/Home Equity Loan is that don’t have to make any payments on the reverse mortgage until you no longer use your home. Repayment of the reverse mortgage occurs when your house is sold.
If you have no heirs, then a reverse mortgage may be a perfectly viable option to supplement Social Security, meet unexpected medical expenses, make home improvements and more. If you do have heirs, then they would receive the balance of any proceeds from the sale of your house after the reverse mortgage is repaid.
The two primary types of reverse mortgages are “Proprietary” reverse mortgages and Home Equity Conversion Mortgages (“HECMs”). HECMs are regulated by the U.S. Department of Housing and Urban Development (“HUD”) and insured by the Federal Housing Authority (“FHA”). The overwhelming majority of reverse mortgages taken are HECMs, which have a limit of $625,500.
Proprietary reverse mortgages are used much less frequently and are not subject to HECM regulations and not federally insured. Proprietary reverse mortgages are sometimes called “jumbo” reverse mortgages because they are typically taken on higher value homes. Proprietary reverse mortgages may be advantageous for some, but they offer fewer protections for homeowners, fees to obtain them are not restricted, and the market is highly fragmented, which makes it hard to comparison shop.
For most, an HECM is the reverse mortgage option to consider, but there are many factors to consider before deciding whether an HECM is right for you. We welcome a conversation to help you consider if an HECM may be helpful complement to your retirement plan.
Beyond our conversation, there are Borrower, Property and Financial requirements to become eligible for an HECM, as well as costs to obtaining and maintaining a HECM. Importantly, all applicants must also meet with a HECM counselor to ensure that you can make an independent and informed decision about whether an HECM meets your specific needs.
To be eligible as a borrower, you must be 62 year of age or older, reside in a home you own outright or with a small mortgage, not owe any federal debt and you must have the resources to continue the expenses of maintaining your property on a timely basis (property taxes, insurance and association fees). Your property must meet FHA and flood requirements as a single family home or approved condominium, or a 2-4 unit home with one unit occupied by the borrower. Your income, assets, monthly expenses, credit history along with timely payment of property taxes and insurance will be all be verified .
A HECM includes several fees and charges (initial and annual mortgage insurance premium, origination fee, interest and servicing fees). Many borrowers pay most of these costs out of the proceeds of the HECM, which means you don’t have to pay them out of pocket, but which also reduces the net loan amount available to you. The amount you can borrow will depend on the age of the youngest borrower, current interest rates and the lesser of the appraised value of your home of the HECM FHA mortgage limit of $625,500.
An HECM can be a valuable tool to help improve the probability that you will meet your retirement income needs. Beyond tapping the equity you’ve accumulated in your home for immediate cash flow needs, HECMs can be used by some to reduce the opportunity cost of keeping excess cash on hand in retirement as cash earns less than other assets over long periods of time. HECMs also provide flexibility during bear markets as an option to tap instead of selling investments. As a result, proper utilization of HECMs in conjunction with your retirement plan can provide needed cash flow for living expenses and/or potentially increase the life expectancy of your retirement savings.
There are several options to consider to using the equity in your home help fund current or future living expenses. Which option is best will depend on your financial situation and personal preferences about where you want to live. With more and more retirees choosing to “age in place”, having an understanding of HECMs is an important step in making an educated decision.
Talk to your wealth advisor or schedule a meeting to have a conversation about which of the available options makes sense for your retirement plan.