Downsize to a New Home With a Reverse Mortgage
Last week we explored how you could use a reverse mortgage to produce an income for life while allowing you to live in your home until your death or you move out. We also considered the possibility of using a reverse mortgage to refinance an existing mortgage, thus eliminating a house payment and possibly creating additional monthly income.
This week we will look at a few more creative ways to use reverse mortgages, as suggested by financial planner Michael Kitces.
While most of us think of a reverse mortgage as a way to unlock equity in a current home without having to sell it, Kitces points out that another use for a reverse mortgage is buying a new home. While the buyer will need a larger than normal down payment due to the lower lump sum limits of a reverse mortgage, this technique can be used to increase cash flow while downsizing a home.
Here is how this might work. A couple owns a house worth $300,000 with a $125,000 first mortgage. The monthly payment is $800. They would like to downsize to a smaller home costing $200,000. One option is to sell the current home and use the proceeds of $175,000 to buy the new one, obtaining a traditional $25,000 loan with a $200 monthly payment.
Another possibility would be to use $100,000 of the sale proceeds as a down payment on the new home and finance the remaining $100,000 via a reverse mortgage. The balance of the proceeds of $75,000 could go into a portfolio and generate $300 a month for life.
This eliminates the house payment and also increases their monthly income. The result is an increase in available cash of $1,100 a month over staying in the current home and $500 a month over selling the home and obtaining a traditional mortgage. The owners would get to live in the property until death or they moved out. They also would still have $100,000 of equity in the house if they did need to sell it.
Still another option, which I touched on last week, is to supplement your monthly cash flow with a reverse mortgage long before you’ve depleted all your assets. By using a reverse mortgage early on, homeowners may be able to preserve and extend their liquid reserve.
Here is an example Kitces gives of how it might work. A 72-year-old couple spends $6,000 a month and collects $3,500 from pensions and Social Security. The remaining $2,500 a month comes from their $400,000 portfolio, which is an unsustainably high withdrawal rate of 7.5%.
They have a $400,000 home with no mortgage. By obtaining a HECM Saver reverse mortgage they could receive $1,300 a month for life. This would reduce their withdrawal from their portfolio to $1,200 per month, a sustainable 3.6%. This could conceivably preserve their investment nest egg for the remainder of their lives..
Because payments from a reverse mortgage do not increase with inflation, and because they use up home equity for current living expenses, a reverse mortgage is always a strategy to be evaluated carefully. Thus you need to be careful not to begin receiving reverse mortgage payments too early. The youngest you can be to apply for a reverse mortgage is age 62, but in most cases it may be best to wait until you are in your 70s or 80s. The longer you wait, the higher the monthly payment.
A reverse mortgage is not for everyone. Used wisely and appropriately, however, it may make a difference in extending your standard of living for many more years and possibly for the rest of your life.