Many people who haven’t saved enough to cover 20, 30 or even 40 years of living expenses during retirement do have one major asset: a home. If you own a home and are at least 62 years old, you may be able to convert your home equity into cash using a reverse mortgage, which can provide you with a much-needed source of income during retirement.
Reverse Mortgage Basics
With a reverse mortgage, you borrow against the equity in your home to get a lump sum, a fixed monthly payment or a line of credit. No repayment of the principal or interest is made until you sell the home or pass away, and since these are non-recourse loans, you (and your estate) will never owe more than the home’s value. Since older borrowers generally qualify for larger loans, most people wait until they’re well past 62 to take a reverse mortgage.
The Standby Reverse Mortgage
A relatively new way to boost your nest egg is the standby reverse mortgage strategy, aimed at people who are as young as 62. The strategy is based on taking a reverse mortgage line of credit and allowing the unused balance to grow at the same rate the bank charges on the line of credit. That means you can set up a line of credit as early as age 62 and let it grow over time.
Here’s an example: Say you obtain a $100,000 line of credit at a 5 percent interest rate. If you use the money, interest accrues and becomes part of what will eventually be repaid. If you don’t tap the money, however, your credit line grows by that same 5 percent. Assuming the interest rate doesn’t change, the credit line would grow to $105,000 after one year, $110,250 after two years, and so on. If you left the credit line untouched for 20 years, it could reach more than $265,000—which could be converted to a nice monthly income when you decide to access the funds.
In real life, these credit lines carry adjustable interest rates that change monthly or annually. After the lender sets your credit limit (taking into consideration interest rates, your age, the value of your home and where it’s located), your credit line will grow by the then-current interest rate—which could be higher or lower than the original rate—plus 0.5 percent (the annual insurance premium on the loan).
Of course, this strategy works best if you leave the credit line alone and resist the temptation to use it on nonessentials. The more money you leave in the account, the more it can grow over time—and the larger your monthly income will be once you start using the credit line. Still, the money is there if you need it—say, to pay for unexpected expenses like car repairs and medical bills, or to give you time to recover from a downturn in the stock market.
It’s also important to note that setting up a reverse mortgage can be expensive, due to loan origination fees, the appraisal fee, closing costs and the like. Because it can take time for any credit line growth to offset these costs, the standby strategy isn’t ideal as a short-term play. Instead, it works better if you plan on letting the credit line grow for longer than just a few years.
One final consideration: Any reverse mortgage reduces the amount of available equity you have in your home, which could become a problem if you want to move into a different home or buy into an assisted-living facility. And while you won’t pass on any debt to your heirs—even if the loan is greater than the value of the home—there may be little left for you and/or your heirs after the loan is repaid. Still, a standby reverse mortgage, when used judiciously, can provide a solid income during your later years, when you may need it most.