After the Great Recession (from December 2007 through June 2009) and even before, finding enough money to finance retirement was an increasingly futile pursuit. There just wasn’t enough equity built up to establish a life at the standards one would expect in retirement.
While stock values plummeted, taking retirement accounts with them, the housing market was even more devastated, given the point that over-financing of a weak housing market is what brought down the financial markets in the first place. The lack of lending squeezed jobs out of existence. But the shredded housing market woke the American Dream out of its slumber. Without equity in homes, retirement plans went right out the window.
With the Great Recession receding into the background and stock markets in fine fettle, many Americans were still left far behind where they wanted to be for their retirement years. To compensate, many have turned their sights on retirement communities abroad, where the cost of living is cheaper.
Now the trick is to use US earnings, which have some value, for living expenses where the dollar has more stretch than Florida or Phoenix or other, traditional, retirement destinations.
Again, it helps to have U.S. earning power used for spending power in countries where a dollar goes a long way, a dynamic that has caused retirement communities to spring up in Latin America , for example, where the cost of living is comparatively modest.
This still needs financing, however, and one under-utilized option remains, which is to apply for a reverse mortgage loan on your house. This involves, essentially, setting up a line of credit based on the equity you own in your home.
By comparison, a typical couple in their retirement, sells their home and takes the money to fund a new place, often in a warmer climate. With a reverse mortgage, the couple does not sell the home. Instead, they keep it, often until they die, at which point their heirs take over what is left of the loan.
Let’s crunch some numbers. A couple takes out a 30-year loan of $200,000 to buy a home. Twenty-five years later, they have built up considerable equity on the home, although they still owe the bank – just to make this easy – $20,000 of principle. The value of their home has also gone up considerably, so now they own most of the equity of a home worth $250,000 or more.
Instead of selling their home, the couple takes out a reverse mortgage. Just as it says, this is where the bank pays the couple based on the equity they own in the home.
There are two types of money. One is actual cash in the hand. The other is the value of something on paper. In this case, an the bank acknowledges that the equity represents a certain value. If the couple’s equity is worth $200,000, a lender agrees to pay them up to that amount in either a lump sum or in monthly installments. In this manner, the couple hasn’t sold their home, but they are chipping away at the sum they are worth on paper.
Couples can finance their retirement this way. If they want to move and buy a new home with cash, they can apply for a reverse mortgage on their first home and buy the second home. Meanwhile, they can move and rent the first home to a tenant. Or they can simply use a reverse loan to finance their modest living expenses. They can stay in their home and use their equity, in essence, to fund their retirement.
There are some things borrowers should understand before accepting a reverse mortgage contract. First, since they still own their home, they still have to pay property taxes and carry homeowner’s insurance against liability claims. Second, the loan they paid down for 25 years is now getting larger again. They should know what kind of debt their children will inherit and make sure this is not going to be a burden on them.
This depends, of course, on how long the couple lives. Reverse mortgages are not allowed on home loans until the youngest signatory on the loan turns 62 years of age. Accepting the point that living expenses are relatively modest at this point is one thing; spending lavishly with a home equity loan could do severe financial harm. This money needs to last. At some point, everyone slows down as health diminishes. But healthcare costs soar just as recreational expenses diminish.
Generally, folks thinking of applying for a reverse mortgage are up against some tough choices. If you are of substantial financial means and have adequate retirement funds to spare, you generally do not think of taking out a reverse mortgage – after all, borrowing always costs money; in this case it might cost your children money or it gives away some of the equity they may have inherited.