Strategic Use of the Reverse Mortgage – Get a Reverse Mortgage and Make Payments
The strategy to make a payment on a reverse mortgage sounds weird. It is weird, but it has some really powerful benefits. If making a payment on a reverse mortgage impacts the quality of your retirement, you may want to skip this and check out this strategy.
What would you rather do?
Make a monthly mortgage payment every month and never see that money again?
Or make a monthly mortgage payment where every single dollar paid accumulates into an account you have access to at any time? Not only do you have access to this account where all the reverse mortgage payments you make go, but the funds in that account are growing so there is more money available than you ever paid in.
The strategy is what I call “The Switch”. It is simply refinancing into a reverse mortgage and then continuing to make monthly mortgage payments. These payments not only pay the loan balance down just like your current loan, but the payments increase the line of credit dollar for dollar. Plus, the funds in the line of credit are growing at the current interest rate of the loan plus .5%.
Making the switch gives you a significant amount of financial flexibility. Because monthly mortgage payments are voluntary. you can pay as much or little as you like, when you like. You can decrease, increase, stop, resume, and skip monthly mortgage payments at any time. You still have to pay property taxes, homeowners insurance and other housing related expenses.
Look, I get it. This sounds too good to be true. If the reverse mortgage really works the way I just laid out, why aren’t more people doing this? The answer is very simple.
People that have a good income, assets and are generally strong financially, never consider a reverse mortgage as part of a retirement plan.
Why would they? Reverse mortgages are for people that are low income, in a financial bind and have no other alternatives, right? Wrong.
People that are in strong financial positions during retirement can oftentimes benefit more from a reverse mortgage when used strategically than those that need it for financial reasons.
I could fill pages and pages about this in a book with the benefits of making the switch to a reverse mortgage from a regular mortgage. Instead of doing that I will give you some examples of what is possible when you make the switch. Interest rates and fees are for illustrative purposes only.
Here’s An Example of What Can Happen When You Make Payments on a Reverse Mortgage
George and Wilda are both 63 years old. They own a $650,000 home in Oregon and have a $175,000 mortgage with 4.74% interest rate. They have 15 years left on their loan with monthly principal and interest payments of $1360.
Between Social Security and pensions, they have a $4200 monthly income and they have $550,000 in retirement. The mortgage payment is not a problem, they have plenty of income to do the things they want, and they feel comfortable knowing they have a sizable retirement.
Is this a couple that “needs” a reverse mortgage? No. However, they read this really great book about the strategic use of reverse mortgages and were intrigued to see how making the switch could benefit them and were intrigued by the idea making a payment on a reverse mortgage.
Here are the basics of their reverse mortgage loan:
Principal Limit (most they can borrow): $248,950
Initial Interest Rate: 5.995%
Growth Rate (rate at which available funds in line of credit grow): 6.495%
Expected Rate (used to determine how much can be borrowed): 5.685%
Fees:
Origination: $6,000
3rd Party Fees: $5148.95
Initial Mortgage Insurance: $13,000
Total Fees: $24,047
Line of Credit: $49,902
Rates as of 9/12/2022. The initial APR is 5.995%. The loan has a variable rate, which can change each month. The rate is tied to the 1 year CMT plus a margin of 2.375%. There is a 5% lifetime interest cap over the initial interest rate. This means that the maximum APR that could be imposed is 10.995%. Rates and funds available may change daily without notice. Closing costs vary by property state. Please call or visit online for further details.
Here is what the switch looks like over time for this example assuming they continue to make their monthly payment of $1360 towards the reverse mortgage, interest rates don’t change, and the home continues to appreciate at 4%.
This chart is very simple. The light gray bar is the home value assuming a 4% appreciation. The dark gray bar is the loan balance. The black bar is the line of credit.
If we look at year 15, we see that they have a $539,558 line of credit and a mortgage balance of $107,000 simply from refinancing and continuing to make the mortgage payment of $1360 towards the new reverse mortgage loan. Granted, had they kept their current loan they would have the loan paid off. But they now have access to over half a million dollars they can access income tax free. (consult a tax professional)
Should they choose to do so, they could continue to make payments on the reverse mortgage to get the loan balance down even further as long as they do not pay off the loan completely. If you pay off the loan, or pay it down below $50, the loan will go away. You will no longer have access to the line of credit.
You see that they are starting off with a $49,903 line of credit. Plus, they paid $244,800 in mortgage payments over 15 years. The sum of those is $294,703. Yet we have an available line of credit in the amount of $539,558 a difference of $244,855. How is that possible? It’s because in this example the line of credit is growing at 6.495%.
Obviously having access to $539,558 of income tax free funds is a pretty big deal. However, we still have a couple with good income and lots of assets and they don’t have a need for the reverse mortgage or that huge line of credit. Why would they want to consider the reverse mortgage and make payments?
You must keep in mind that getting a reverse mortgage is not always about an immediate need. It is about being prepared for the stuff that gets thrown at you during your retirement.
Three Reasons Why Getting a Reverse Mortgage and Making the Payment Make Sense
Scenario 1: Secure Your Spouse Financially with a Reverse Mortgage
George and Wilda have a great income which is why the mortgage payment is not a big deal. George gets $1900 a month in Social Security plus $600 in pension. Wilda gets $1700 a month for Social Security. Regardless of who passes away first, there will be a loss of $1700 a month in household income.
The monthly principal and interest payment is $1360. When either one passes away, that mortgage payment will be 54% of the household income. Throw taxes and insurance of $350 into the mix and it accounts for 68% of the household income. Regardless of which spouse remains, they will be financially strained due to the mortgage payment.
Let’s assume that 10 years into the reverse mortgage George passes away. At that point Wilda can choose to stop making the mortgage payment. She would still need to pay property taxes and homeowners insurance. This frees up $1360 a month in cash flow.
Between the mortgage payment being gone and a reduction in household expenses, Wilda is in virtually the same financial position before George passed away. She will not be financially strained when he dies.
On top of this, in 10 years there is still a line of credit in the amount of $322,369 that Wilda has available. When Wilda faces large expenses such as home repairs or car problems she can pull funds from the line of credit income-tax free. She won’t need to pull funds from retirement which will increase her chances of running out of money and potentially create a taxable event.
Is getting the reverse mortgage now to ensure the financial stability of your spouse when you are gone a good reason to get a reverse mortgage? Of course it is.
Scenario 2: Being Prepared for Financial Shocks with a Reverse Mortgage
15 years after making the switch to the reverse mortgage and making payments, Wilda has made the decision that she needs to put George into a nursing home. His dementia has become too much for her. Emotionally and physically, she can no longer take care of him. Plus, he is a flight risk which puts him in significant danger and creates significant stress and anxiety for Wilda.
The doctor has given a prognosis of a 1 to 3 year life expectancy based on the progression of the George’s dementia.
The good news is based on a solid 5% return. Their retirement accounts have grown over the last 15 years from $550,000 to $1,143,000.
The bad news is that the nursing care facility costs have also increased and the facility she wants to put him in is $19,500[1] a month, or $234,000 a year.
The bad news turns worse when the financial planner tells Wilda she will need to draw $360,000 a year from retirement in order to pay $234,000 for nursing facility because she needs the extra funds to pay state and federal taxes.
If George lives for 3 years and assuming a 5% return in the investment portfolio, Wilda only has $73,000 left over out of the $1,143,000 she started with.
However, because they made the switch and continued making payments on the reverse mortgage, Wilda still has well over $539,558 sitting in the line of credit which she can utilize through the rest of her retirement to live comfortably.
The other option available to Wilda is to pay for George’s nursing home care using the $539,558 available in the reverse mortgage line of credit. This would pay for 2 years and 4 months of care.
Assuming George lives 3 years, only about $180,000 would need to be drawn from the retirement account.
By using the reverse mortgage funds first, we are allowing the funds in retirement to continue to grow. Assuming a 5% return the $1,143,000 turns into $1,260,157 in 2 years.
By paying for the first part of care with reverse mortgage proceeds and the rest out of retirement, Wilda will still have $1,080,157 in her retirement account.
This would save Wilda approximately $164,000 in taxes[2] because she is using tax free funds from the reverse mortgage line of credit first.
These are just two examples of why it makes so much sense to switch from a regular mortgage to a reverse mortgage. Check out the other strategies using the reverse mortgage. But first, we need to cover some other scenarios.
In order to make the switch and follow the examples you just read; you must get the adjustable rate reverse mortgage. I know adjustable rate mortgages freak people out, so let’s take a look at what happens in a scenario where rates go up and the home value stays the same.
All the numbers in this scenario are the same as the “George and Wilda” example except we are going to assume the following:
- Interest rate increased to 10.995% the month after they got their loan.
- The value of their home never increases.
An interest rate increase right off the bat of 5% is highly unlikely, as is the likelihood of the home never increasing in value.
However, this is what most people would consider a worst-case scenario so it is important to show what would happen.
The light gray bar is home value; it does not change as we are assuming the home never appreciates. The dark gray bar is the loan balance which is decreasing over the first 15 years at which payments have stopped. And the black bar is the line of credit which is growing over time.
If you compare the outcome of the reverse mortgage to the current mortgage at the 15-year mark, there are some big differences.
First, with the interest rate increase, the loan balance at the end of 15 years is $409,819 assuming they did not increase their mortgage payment and continued to pay the $1360 they were paying previously.
Remember, a reverse mortgage is a voluntary mortgage payment loan. (You still have to pay property taxes, homeowners insurance and other property expenses.) Just because interest rates increase does not mean the payment needs to increase. If they didn’t make the switch, their loan would have been paid off.
However, in this example, in year 15, the line of credit has grown to $875,796. There is $336,238 more available in the line of credit than the previous example where the rate stayed low. This is possible because the growth in the line of credit has nothing to do with the value of the home. The growth in the line of credit is based solely on the current interest rate plus .5%.
This new chart, even though it represents no appreciation, gives us an idea where they would be at in 15 years should the real estate market crash again like it did during the housing bubble of 2008. Assuming the home value dropped to $650,000, the line of credit would be worth $225,796 more than the home.
This example of the home never appreciating is highly unlikely based on historic appreciation rates, as is the rate hitting its cap and staying there for 15 years straight. However, it is an example of what could happen with another housing bubble or severe depression.
On the previous chart we saw that the home was expected to be worth $1,170,613 in 15 years based on 3% appreciation. But, what if we experienced a crash in real estate values like we did in 2008 thru 2012? During that crash housing prices in dropped about 50%.
In other words, the worst-case scenario of rising interest rates and falling home prices isn’t that big of deal. In fact, it puts you in a better financial position than most. And can actually help preserve equity.
Scenario 3: Worst Case Scenario – Catastrophic Event with the Reverse Mortgage
George and Wilda made the switch to a reverse mortgage and continued to make payments for 15 years. Interest rates never changed much from when they got their reverse mortgage initially.
At the end of 15 years they decided to stop making the mortgage payment. They were disappointed that they never paid the loan balance off like they would have had they stuck with the regular mortgage.
Five years later at the age of 83, they decided they wanted to sell to be closer to family. Unfortunately, about the time they decided they were ready to move, a housing bubble hit and they lost 45% of the value of their home and were having a difficult time selling it.
Luckily, they made the switch 20 years ago. They were able to pull out the $752,755 available in the line of credit and buy a home near their family for $400,000 cash. They were also able to put an additional $352,755 in their savings account.
After they moved into their new home, they informed the company servicing the loan that they no longer lived in the home. The servicing company began the foreclosure process on the previous home six months later. The foreclosure process was completed six months after that.
George and Wilda were not responsible for any of the losses associated with their reverse mortgage and it didn’t affect their credit. Remember, this is a non-recourse loan which means the lender cannot pursue you, your estate or your heirs for any losses associated with this loan. Nor does this show up on a credit report or affect credit scores.
This is an extreme scenario, what I would call a devastation event, but it is possible. And if you don’t think we will ever have a housing bubble like we did in 2008, just remember, history has a habit of repeating itself.
Making the switch out of your current mortgage into a reverse mortgage and continuing to make a monthly payment presents so many different opportunities. This includes flexible monthly payments, creating an additional source of income tax free proceeds (consult a tax professional), being better prepared for financial shocks and reducing strain on retirement funds.
[1] https://www.genworth.com/aging-and-you/finances/cost-of-care.html
[2] Please consult with a tax professional in regards to taxes on retirement funds.
