Imagine it’s Christmas Day and you’re sitting on the sofa in the living room of your son’s house. A beautiful Christmas tree covered with ornaments and bright lights stands in the corner. The turkey baking in the oven fills the air with warm and delicious smells. Your favorite people in the whole world – your children and grandchildren – are sitting around the room and laughing and chatting and enjoying each other’s company.
You stare at the beautifully wrapped gifts from your loving family stacked in a large pile at your feet. You know you should feel happy and blessed, but you don’t. In fact, you’ve been dreading Christmas for months – just like you have for each of the last few years.
You glance furtively around the room at your children and grandchildren, hoping they haven’t noticed your unhappiness. They all have piles of gifts at their feet, too.
Sadly, not a single package in the entire room is from you. All you brought was a few plates of cookies. Your family absolutely loves your cookies, but you hate that you don’t have more to give.
It’s not that you don’t want to give more. Your heart breaks that you can’t. You know that giving isn’t about reciprocating, but it still bothers you deeply that you can’t give more in return.
Your family wouldn’t dream of holding this against you – they know your finances are tight. But to you, it’s like a rain cloud looming over what should be a bright and joyful day.
Sadly, this was the situation one 74-year old woman, who we’ll call Betty, found herself in. She and her 76-year old husband, who we’ll call Joe, retired comfortably a number of years ago, but inflation had taken its toll on their standard of living. What was once a comfortable retirement income now barely covered their living expenses.
Even worse, their credit cards were maxed out because of a wave of recent medical bills. Their adult children helped where possible, but they had limited resources, too.
This was not the retirement Betty envisioned. She actually started crying as she described how she couldn’t afford to buy gifts for her beloved grandchildren at Christmas. She badly wanted to make a change, which is why she and Joe decided to check into a reverse mortgage.
Two goals for the reverse mortgage
Joe and Betty never made a lot of money in their working years, but they did accomplish something big: they paid off their house before retirement. That accomplishment would now prove to be a game changer for their retirement lifestyle and financial security.
When I first chatted with Joe and Betty, they told me they had two goals for the reverse mortgage:
- Eliminate the credit card balances. They owed about $25,000 and the payments were killing them. They weren’t making any progress paying down the balances because of the high interest rates. They had cut back on groceries and eating out and had cancelled their cable package to free up cash for the credit card payments.
- Build up reserves. Once the credit cards were paid off, they wanted to build up their savings. They wanted reserves so they would never have to run up the credit cards again.
Because their home was free and clear and had appreciated nicely over the years, Betty and Joe had a lot of equity to work with. They estimated that their home was worth about $225,000. Though a reverse mortgage offers just a portion of the value, they would still have a very nice chunk of money available to pay off bills and build up their reserves.
Before we dig into how much Betty and Joe were able to get, let’s first cover some basics about how a reverse mortgage works.
How does a reverse mortgage work?
The most popular reverse mortgage in America today is the home equity conversion mortgage, or HECM. The FHA-insured HECM enables seniors 62 or older to convert a portion of the equity in their homes into cash.
No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) is living in the home and paying the required property charges.
You remain the owner of your home and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in the home.
The HECM is a non-recourse loan; the most that will have to be repaid is the value of the home. If the home isn’t worth enough to pay off the entire balance, the shortage will be paid off by FHA.
The HECM is a mortgage, so it has an interest rate like any other mortgage. Rates are usually comparable to traditional 30-year fixed mortgage rates.
If you choose not to make a mortgage payment (the whole point, right?), accrued interest is simply added to the loan balance over time.
Reverse mortgage borrowers commonly use the proceeds to eliminate mortgage or other debt payments, finance home improvements, or supplement existing retirement income or assets.
The reverse mortgage is very versatile; it can be fine-tuned to achieve your individual goals and needs. Proceeds can be received as term or tenure income, line of credit, lump sum, or some combination of all of these options.
A financial game changer
Based on their goals, I recommended that Joe and Betty take the proceeds as a combination of lump sum and line of credit. In other words, grab $25,000 at closing to wipe out the credit cards and leave the rest in a line of credit for future unexpected expenses.
Joe and Betty stood to save a whopping $700 to $800 per month just by paying off the credit cards. That alone would plug the gushing leak in their budget and make them reasonably comfortable. The additional line of credit would provide future financial security.
Joe and Betty qualified for a net principal limit of about $105,000 after closing costs. They chose to take $25,000 at closing to pay off the credit cards and leave the remaining $80,000 on the line of credit. This was far more money than they had ever had at their disposal in their entire lives. Needless to say, they were excited and hugely relieved. They actually could conquer the mountain of credit card debt that had been such a financial burden for so long.
Even better, the available line of credit would automatically grow and compound larger based on an annual growth rate. The $80,000 was just the starting amount. The available credit increases over time and automatically gives them access to more equity.
Not a loan of last resort
It’s unfortunate, but many people see the reverse mortgage only as a last resort for broke and desperate people. The reverse mortgage can sometimes help a desperate person, but often it can’t. Broke people with destroyed credit and tons of debt often don’t qualify for a reverse mortgage.
Joe and Betty probably felt pretty desperate as their bills mounted, but their credit was still fine and they were current on their property charges. Fortunately, things weren’t so bad (yet) that they were at risk of not qualifying.
The reverse mortgage is best used not as a last resort but as a safety net. If it’s a last resort, it might already be too late.
Wade Pfau, a prominent retirement researcher and thought-leader in the reverse mortgage space, recently wrote:
[The reverse mortgage] must not be viewed in isolation, but rather as how it contributes to an overall plan. The value of the reverse mortgage can mostly be found in its diversifying benefits for investments in retirement. Taking distributions from investments can dig a hole that is hard to recover from, and wise use of the reverse mortgage protects the investment portfolio in retirement.
If you have retirement assets, the reverse mortgage can be an additional resource to cover financial emergencies. When you have multiple financial options, you’re not forced to dip into retirement accounts to cover unexpected expenses. That enables you to more effectively protect and preserve those assets for longer.
If you don’t have retirement assets, a reverse mortgage can help you stay out of credit card debt. Instead of plunking down the plastic, you can use the reverse mortgage to cover emergency expenses.
A reverse mortgage can be a life changer
It might sound like hyperbole, but a reverse mortgage really can be a life changer. For Joe and Betty, it definitely was.
When I told Betty the good news that her reverse mortgage was complete, the relief and excitement in her voice was obvious. Christmas was just a few months away and she was looking forward to making it one to remember. Now that the credit cards were gone and they had reserves to cover emergency expenses, Betty was excited to finally be able to splurge on her grandkids.
Yes, a reverse mortgage really can be life changing.
If you’d like to get an estimate of how much you can get from a reverse mortgage, check out our reverse mortgage calculator.