Despite the recent soft spot in the real estate market, the longer term picture for home values has been quite positive, resulting in a current total of $10 trillion in home equity (housing value less outstanding mortgage debt). Real estate represents an average of 30 percent of total wealth for older Americans, the largest non-pension asset.
If you’re approaching retirement, you may want to be able to tap your home equity to generate retirement income. Obviously, you can sell your house, but then you still need someplace to live. You can get a home equity loan, but will have to make loan payments.
A third alternative is a relatively new and less understood financial product called a reverse mortgage. If you and your spouse are age 62 or over and live in your home, you can potentially qualify for a reverse mortgage which enables you to withdraw a portion of your home equity, make no form of monthly payment, and stay in your home. The loan will be repaid when you sell your home or when you die. Federal legislation guarantees that you do not give up the title to your home.
With a normal home mortgage, your debt gradually decreases over time as you repay the loan, and your equity rises. With a reverse mortgage, you make no payments, so the debt increases over time, and the equity decreases.
The amount you can get from a reverse mortgage will depend on your age, the home’s value, and the current interest rate. You will owe no tax on the money withdrawn and there are no limits on how you use it. The choices for how to receive the funds are:
– Single lump sum
– Monthly income for life (or you and your spouse have both died)
– Credit line, drawing on the funds as needed
The Home Equity Conversion Mortgage (HECM) is insured by the Federal Housing Administration (FHA), which dictates how much you can borrow, based on your age and your home’s value, and places limits on loan costs. Because these fees are not paid out of pocket, but are added to the equity advances and interest expenses, government regulations require disclosure.
How much can you borrow? Under the HECM Program, assuming current interest rates, average fees and closing costs, a qualifying homeowner with a debt-free home worth $200,000 could receive a maximum lump sum or credit line of $94,605 or a monthly payment of $576 per month for life. This is unlikely to be enough to live on, but could be a nice supplement to Social Security benefits and other sources of retirement income.
If you have an outstanding mortgage, the reverse mortgage will first be used to pay it off. Reverse mortgages can actually be used to purchase a home, resulting in a place to live with no monthly payments for life, which is particularly useful if you find it necessary to move to new home that is more suited to your needs in retirement.
Rates on reverse mortgages adjust monthly, semiannually, or annually, depending on the program you choose, and there is a lifetime cap that prevents your rate from going above specific government guidelines. Although the actual rate will affect the future payoff of the loan, it will have no effect on your payment, since you are not making a payment.
For more information about reverse mortgages, see www.aarp.org/moeny/revmort.
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Vickie Bajtelsmit, Professor of Finance, Colorado State University College of Business, email@example.com, (970) 226-1473