Rethink Retirement with Reverse Mortgages

I’m sure you’ve had plenty of clients tell you they want to pay off their mortgage. After all, being debt-free is a worthy goal, and it brings peace of mind, especially in times of economic chaos. But is it the smartest thing to do? Not necessarily.

In today’s high-inflation world, real estate values have soared. Many long-time homeowners have seen their home values soar to five or 10 times what they paid for them decades ago. Seniors have trillions of dollars of home equity locked up in their properties. Home equity is an excellent cushion for retirement, but only if it is managed properly. Since taxes, insurance and home repairs are rising faster than the rate of inflation, many seniors are not living comfortably despite having little or no mortgage. So, how do your retired clients unlock that capital in their homes without selling the property and paying significant taxes on their long-time gains? By putting their home equity to work.

While many of your clients have been conditioned to believe that all debt is bad, here are some myths about having a mortgage paid off on a primary residence.

While these seem like financially responsible statements, let’s examine each one and see if they really make sense for everyone who retires.

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1. I can refinance my home and borrow out my capital. On the surface, this makes sense, but the reality is that most mortgage companies loan based on income. If a senior lives on a tight budget and applies to refinance, the mortgage company will usually decline the application, arguing that the senior doesn’t meet the refinancing guidelines. Sure, some mortgages are issued based on assets, but if the home equity is the potential borrower’s only asset, they don’t have much other collateral, and there is a low probability of getting a loan. Plus, significant fees are paid that reduce the equity in the house (by loading them into the mortgage). This is probably not a solution for many of your retired clients.

Sometimes, a bank will issue a home equity line of credit (HELOC). While HELOCs typically have a 10-year term, many of your clients have learned that the outstanding principal comes due before they know it. HELOCs are interest-only—banks like it that way—and there are no strict requirements to pay down any principal during the loan term. If the borrower consumes all the loan proceeds, how will they pay off the loan when it comes due? In many cases, there is no opportunity to refinance the HELOC. Now what?

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2. I don’t have to make house payments any longer. Again, this is true on the surface, and it takes the pressure off the homeowner’s monthly living costs. But there’s an opportunity cost here. Tying up a large sum of your capital (to pay off the mortgage) means that money can’t be deployed or invested for higher-yielding purposes. Many mortgages were reset during the low-interest period during the pandemic. A 3% mortgage is an exceptionally valuable asset. By keeping their low-rate mortgage in place, your clients can borrow money from the bank at 3% and earn 5% risk-free on Treasurys or 8% to 9% on average in the stock market or other real estate investments. So, using money that could be earning 5% to 8% to pay off a 3% mortgage is not a good tradeoff for most homeowners.

3. I am more financially secure if my house is paid off. While it’s true that having no debt is a wonderful financial position to be in, it comes with a price. That price is usually the loss of income on the capital tied up in a house. Say your client bought a home for $100,000 cash, and it appreciated at 3% a year. If they bought the house with a mortgage, would it still grow at 3% a year? Yes, of course. So, the mortgage had nothing to do with the appreciation. How you acquire the home (i.e., the asset) is not part of the appreciation equation. By preserving your client’s capital and leveraging the purchase, they have both the mortgage and the investment capital at work. 

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Many of your clients who are retired homeowners are in a difficult position. They are facing the loss of employment income and staring at a home that potentially represents financial security and higher income, but they don’t want to go into debt to get it. Or they may want the house payment monkey off their back for psychological reasons. Most advisors know reverse mortgages (Home Equity Conversion Mortgages, aka HECMs) are a viable solution, but may be reticent to recommend them because of their checkered history. 

HECMs were introduced in 1961 as a way for seniors on limited incomes to stay in their homes, especially if their spouse had passed or become incapacitated. The idea was simple: Trade the equity and future equity in the home for the mortgage and no payments. The home became a deferred asset of the bank. The widow or widower had no more mortgage payments, and the bank owned the seniors’ house when they died instead of their heirs. Everybody wins, right?

In fact, by 1987, the government, seeing the social value of reverse mortgages, passed the Housing and Community Development Act, which authorized the Home Equity Conversion Mortgage program, backed by the Federal Housing Administration. By 1989, the first FHA-insured HECM loan was issued, and widespread adoption of reverse mortgages continued through the 1990s and early 2000s housing boom. 

However, early reverse mortgages did not have any real consumer protection. This led to foreclosures, misleading advertising and the loss of homes when spouses who were not listed on the loan were denied the continuation of the loan’s benefits. These abuses created a lasting stigma on the use and benefits of reverse mortgages, especially among financial advisors. 

Reverse mortgage originations have dropped significantly since the global financial crisis. But in these inflationary times of sky-high housing costs, some financial experts are now re-evaluating reverse mortgages as part of a more holistic retirement strategy. Here are three of the most significant benefits:

When used strategically as part of a holistic plan, reverse mortgages can unlock home equity to enhance retirement income, fund care needs, and protect investment portfolios during market downturns and periods of high inflation. Don’t be so quick to write them off.