What do you think it’s like to be in your late eighties, in declining health, without a dime in the bank, and facing foreclosure? I had the chance to find out when I chatted with a woman in this exact situation. Folks, I’ll tell you, it isn’t fun. Her situation is a case study for home equity loan risk in retirement.
This woman, who we’ll call Norma, was 88 – if I remember correctly. Her husband, who we’ll call Fred, was just a few years older.
Norma’s health wasn’t great, but she could mostly get around OK. Fred, on the other hand, was in bad shape. He could barely do the basics like eating and going to the bathroom on his own.
Fred’s health was in rapid decline and it fell to Norma to care for him. They didn’t have the money to hire professional care and they had no family living nearby. Norma’s devotion to Fred’s care was inspiring, but I could tell that it was a big burden for her.
As we chatted, I also learned that Norma and Fred’s finances were a complete disaster. They were buried under a heap of medical bills and had two mortgage payments. The main mortgage was a traditional 30-year fixed with a low rate and manageable payments. The second mortgage, however, was a home equity loan (also known as a home equity line of credit, or HELOC).
I shudder when seniors on fixed incomes tell me they have home equity loans because I know what a ticking time bomb they can be. It didn’t surprise me when Norma said the payment had recently increased by hundreds of dollars and they were now struggling to pay it.
Home Equity Loan Risk in Retirement
So why did the home equity loan payment increase? The answer is simple: that’s how a home equity loan works. That’s why I think home equity loan risk is too high for retirees on a fixed income. Unfortunately, many accountants, attorneys, and financial advisors still recommend HELOCs to retirees.
You see, Fred and Norma’s HELOC was now past the draw period, which usually lasts for the first ten years. They were no longer allowed to draw on the available credit or make a low interest-only payment anymore. When the draw period ends, the lender “recasts” the payment to force a complete pay back of the balance over the remaining loan term. Their monthly payment was now triple what it used to be.
Norma and Fred were already on a tight budget. Their income wasn’t keeping up with the rising cost of living, so their finances were already tight before the home equity loan payment increased. There was no way they could afford the higher payment. Tragically, Norma and Fred were now facing the very real possibility of losing their home.
Chatting with Norma that day, I discovered what it’s like to be in your late eighties, in poor health, dead broke, and facing foreclosure.
Too Many Bills and Not Enough Options
If you’re young and healthy, you have the time and energy to recover from financial setbacks. But what was somebody in Norma’s situation going to do? She couldn’t get a job or start a business to make more money. She also couldn’t refinance to consolidate her mortgages because she had limited income and her credit was shot. Her family wasn’t coming to the rescue either; they lived far away and had limited financial resources themselves.
What options does somebody in Norma’s situation have? Unfortunately, not many.
Norma and Fred’s best bet was probably to sell the home, use the remaining equity to pay off their bills, and rent a cheap apartment somewhere. That’s probably not what they envisioned for their retirement, but what choice did they have?
I wish I could say there was a positive resolution to this story, but there was not. I tried to help Norma and Fred eliminate their mortgage payments with a reverse mortgage, but they didn’t qualify for enough to settle both loan balances.
A HECM reverse mortgage offers just a portion of the home’s value based on age and current interest rates. Unfortunately, the amount of money available via the HECM was lower than what it would take to pay off both mortgages. Fred and Norma would have needed to come up with cash to pay down their mortgages to make the HECM work. Obviously, that wasn’t an option in their situation.
I really wish Norma and Fred had picked a reverse mortgage instead of a home equity loan. They could have eliminated their mortgage payment and accessed additional equity for unexpected expenses. No repayment would have been required as long as at least one of them was living in the home and paying the required property charges. They would have remained the owners of the home and they still could have left it to their kids.
Unfortunately, it was not to be. The home equity loan (that so many accountants, financial advisors, and attorneys still recommend) was likely going to cost them their house.
If they instead had a reverse mortgage (which so many accountants, financial advisors, and attorneys still consider “risky” for some insane reason), they could have lived securely in their home for many years to come.
A Few Important Lessons
Working with Fred and Norma highlighted a few important lessons that I want to pass on to you:
- Home equity loan risk in retirement is real. HELOCs are risky for retirees living on a fixed income. The more you borrow, the bigger your payment. HELOCs also usually have variable rates, which means your payment increases if rates rise. And let’s not forget the recast, which can double or triple your payment. A HECM line of credit is a far better option. You have all the flexibility of the HELOC, but without the payment risk. No payments are required on a HECM line of credit as long as you live in the home and pay the required property charges.
- There will be a time in your life when you have no capacity to increase your income. You need to have your financial resources already in place before that time comes. Retirement assets, insurance (health, long-term care, etc.), and home equity (via the HECM) can all help you be as financially secure in retirement as possible.
- Your expenses will likely increase substantially late in retirement as your health declines. You may need to pay for in-home care if you can’t take care of yourself or a family member. You may have a lot of medical bills even if you have Medicare and a decent supplemental policy.
- Mortgage payments in retirement can be risky. Even if the payment is manageable at the start of your retirement, it won’t necessarily stay that way over years or decades. Inflation will constantly erode the purchasing power of your income. Even if the mortgage payment itself never changes, your other living expenses likely will. You don’t want to end up in a situation where you have to choose between paying the mortgage or critical medical care.
- It’s important to have multiple financial resources at your disposal. Hopefully you retire with a free and clear home. If so, get a HECM line of credit early in retirement to serve as an additional cash source. Hopefully you don’t need the money right away, which means you can let it grow and compound based on a guaranteed growth rate. By the time you do need the money, you’ll have a lot more at your disposal. If you retire with a mortgage, consider using the HECM to get rid of the payment. You can then build your savings faster and position yourself to more easily absorb unexpected expenses and/or higher medical costs in the future.
- The best time to get a reverse mortgage is when you don’t need it. It’s hard to get insurance on a house that’s already burning down, right? Likewise, it’s often hard to qualify for a reverse mortgage when you really, really need one. The best time to get a reverse mortgage is before you need it. If you’re desperate, your finances and credit may be too far gone to qualify.
Not a Loan of Last Resort
A lot of people think a reverse mortgage is a loan of last resort only for broke and desperate people. I think Norma and Fred disprove that notion. It’s not as easy to qualify for a reverse mortgage today as it used to be. Maybe the reverse mortgage was a loan of last resort in the past, but it’s not so today. If you’re seeking a reverse mortgage because you have no other options, it might already be too late.
A reverse mortgage works best as a safety net and/or retirement planning tool that brings home equity into the retirement funding picture.
This is an updated version of a post originally published December 10, 2018.