A man who I’ll call Jack contacted me about using a reverse mortgage to pay for future medical expenses. Jack made it clear from the get-go that he didn’t want a reverse mortgage now. He just wanted to explore some options and call back in five years to set it up then.
Jack basically wanted to use the reverse mortgage as an “insurance policy” to protect against the financial risk of big medical expenses. It was smart of Jack to think ahead, but here’s the thing about insurance: you have to get it before you actually need it. After all, it’s pretty hard to get insurance when your home is already burning down, right?
I tried to explain this to Jack, but he wasn’t interested in my advice. I also tried to explain that he would ultimately get far more money by getting a reverse mortgage right away. He didn’t need to actually use the money right now, he just needed to get the reverse mortgage set up and ready to go.
Unfortunately, Jack wouldn’t listen to anything I had to say. He just assumed I was being pushy. He got angry and hung up on me.
Folks, I am in no way a pushy person. To me, it’s all about the numbers and what they can accomplish. If Jack was willing to listen, I would have proven that it made more sense to get a reverse mortgage right away. Jack’s unwillingness to listen to my professional advice will probably cost him a lot of dollars and peace of mind over the coming years.
The ideal reverse mortgage candidate
Any good industry professional will acknowledge that a reverse mortgage is not always the perfect solution. However, it is a fantastic program for the right candidate. In my opinion, there are two ideal reverse mortgage candidates:
- Low or no mortgage balance, don’t need the money right now, and no plans to sell the home.
- Large mortgage balance, many years left before it’s paid off, and no plans to sell the home.
Jack fit the first profile to a “T”. His home was free and clear, he didn’t need the money for at least five years, and he had no plans to sell.
Jack was an ideal candidate, but he missed out on a great opportunity because he wasn’t willing to be open-minded and listen my advice. Unfortunately, he fell prey to some conventional “wisdom” that’s been floating around for a while.
The conventional wisdom
Unfortunately, many journalists and financial professionals think it’s better to wait as long as possible to get a reverse mortgage. Check out the following advice, which appeared a while back in an article by Robin Hartill in the Tampa Bay Times:
But if you decide to pursue a reverse mortgage, try to wait as long as possible. Generally, the older you are when you take out a reverse mortgage, the higher your payout will be.
It’s pretty clear from the entire article that Hartill is a reverse mortgage skeptic. However, she seems to mean well and tries her best to offer sound advice. However, like many in the media, she has a faulty and incomplete understanding of how a reverse mortgage works.
In my opinion, there are two main reasons why many commentators say “wait”:
- They see a reverse mortgage as a last resort. Folks, a reverse mortgage is not a last resort. If you’re in dire financial straits, you may not even qualify. The best candidates are those who are at least somewhat financially stable. A reverse mortgage is best used as a safety net. Think of it like “retirement insurance”; it provides an added layer of financial protection. And like insurance, you want to have it in place before you actually need it.
- You tend to qualify for more as you age. This is generally true, but it’s not a guarantee. If interest rates rise or home values fall, you could qualify for less in the future despite being older.
Commentators routinely miss (or ignore) a key feature of the HECM reverse mortgage: growth. If you want the most you can get from a reverse mortgage, you want to maximize the growth. You’ll get far more dollars through growth than through waiting to be a little older. And to maximize growth, you want to set up the reverse mortgage right away and not use it for a number of years.
Don’t believe me? No problem, I’ll prove it! But first, let me cover a few basics so my explanation of the growth feature makes more sense.
How does a reverse mortgage work?
The most common reverse mortgage in America today is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, it likely was a HECM.
A HECM reverse mortgage allows homeowners 62 or older to convert a large portion of their home’s value 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 always remain the owner of the home and you’re free to leave it to your heirs. You heirs will inherit any equity remaining in the home, whether they choose to keep it (by paying off or refinancing the balance), sell it, or let the lender sell it.
The HECM is a non-recourse loan, which means the most that will ever need to be repaid is the value of the home. If the home isn’t worth enough to cover the entire balance, FHA will settle the shortage.
HECM borrowers commonly use the proceeds to get rid of existing mortgage or other debt payments, supplement income, supplement retirement assets, or finance home improvements. You can use the cash for pretty much anything.
The HECM is a mortgage, so it comes with an interest rate like any other mortgage. HECM rates are usually comparable to traditional 30-year mortgage rates. If you don’t make payments (the whole point, right?), any accrued interest is simply tacked onto the loan balance.
HECM proceeds can be received tax-free in the form of a line of credit, lump sum, monthly term or tenure income, or some combination of all of these options.
The option I want to focus on here is the line of credit. If Jack had been willing to listen, I could have explained to him how the line of credit could be a game-changer for his retirement.
How reverse mortgage line of credit growth works
The reverse mortgage line of credit is very similar to a traditional home equity line of credit, or HELOC, except that no mortgage payments are required. Even better, the available line of credit grows larger based on an annual growth rate. This growth feature automatically gives you access to more equity over time if you need it.
As an example, let’s assume you qualify for an initial credit line of $75,000 with an annual growth rate of 5%. If you left the line of credit alone to grow and compound, it would increase to $95,000 after just five years. After ten years, it will have increased to over $122,000!
Because the growth rate applies to the available line of credit, growth compounds on growth. This means that the available credit can really add up over time.
This is also why the line of credit is ideal for homeowners who don’t need the money right now. If you don’t need the money, you can just let the line of credit sit and grow. By the time you do need the money, you’ll have a lot more than what you started with.
The growth rate is also designed to keep up with prevailing interest rates. If interest rates rise in the future, the growth rate will as well. It might sound crazy, but higher interest rates could be very beneficial for you!
Why waiting makes no sense
If Jack was more open-minded, I would have shown him how the reverse mortgage line of credit growth works. I would have been able to prove the benefit of getting a reverse mortgage right away versus following the conventional “wisdom” of waiting until he’s older.
Let’s look at another example to see what Jack may have missed out on. I don’t remember all of Jack’s details, so I’m going to make a few assumptions here.
Let’s assume Jack is single, 65, and has a free and clear home worth $300,000. Let’s also assume he will not take any money at closing. He wants to leave as much money as possible on the line of credit to maximize the growth.
Using our fantastic reverse mortgage calculator, we find that Jack qualifies at 65 for a starting line of credit of $132,500 (based on the expected interest rate at the time this article was published). The annual growth rate is 5.87%.
Figure 1 shows the amortization schedule generated by our reverse mortgage calculator. As you can see, after just one year (top arrow) the line of credit will have grown to $140,490.
Now, let’s see what happens if Jack instead follows the conventional wisdom and waits until he actually needs the money. Let’s say he gets hit with a bunch of medical bills just one year later at age 66 and decides to get a reverse mortgage then.
Assuming home values and interest rates haven’t changed, Jack’s line of credit would start off at $134,600. That’s $2,100 more than he had at 65, but it’s almost $6,000 less than if he’d already had the reverse mortgage for a year. Wow!
Now, what if Jack instead waited five years to get a reverse mortgage? How much would he get by qualifying at 70? A comparatively measly $140,300. That’s still a lot of money, but it’s nothing like what he would have gotten through growth.
As you can see in Figure 1, if Jack had gotten the line of credit at 65 and let it grow for 5 years, he would have $177,570 available. That’s over $37,000 more than he would get by waiting until he turns 70.
Wow, what do you think? Should you wait to get a reverse mortgage until you actually need it?
Waiting can be a loser’s game
Folks, I hope it’s clear that waiting to get a reverse mortgage can be a loser’s game. The pundits and commentators mean well, but their advice to wait is often based on a flawed or incomplete understanding of the reverse mortgage.
If you have a free and clear home like Jack, the best time to get a reverse mortgage is as soon as possible. You don’t need to use the money, just get it set up and let the line of credit grow. By the time you do need the money, you’ll have a lot more to work with than waiting and qualifying based on a higher age.
Remember, the reverse mortgage is best used as a safety net. It’s a form of “retirement insurance”. If your home is already burning down, it’s too late to get insurance, right? It’s the same deal with the reverse mortgage. You need to have it in place before you actually need it.
Let’s also not forget the risks associated with home values and interest rates. If home values fall and/or interest rates rise over the time you’re waiting, you could end up with far less than expected even though you’re older.
And what if you get hit with a bunch of big medical bills while you’re waiting? If you’re carrying a lot of debt and/or have medical collections on your credit, your financial profile may be too risky to meet the HECM lending guidelines. You may not even qualify anymore.
Folks, if a reverse mortgage benefits you, the time to get it set up is sooner rather than later. You don’t have to use the money, right? Just get it set up and let it grow. When you actually do need the money, you’ll likely have a lot more to work with than if you wait.