Reverse mortgages allow borrowers to access a portion of their home equity in a variety of payment options, including a lump sum, monthly installments or through a line of credit. Of all the different options, the line of credit strategy has been gaining considerable attention from financial planners largely due to its unique “growth feature.”
Similar to a traditional Home Equity Line of Credit (HELOC), a reverse mortgage line of credit accrues interest only on the amount that is borrowed. An advantage of the reverse mortgage credit line, however, is that borrowers are not required to make monthly payments to the lender (although you must still pay your property taxes and insurance). Unlike a traditional HELOC, a reverse mortgage line of credit cannot be cancelled or frozen by the lender, enabling borrowers to draw on the credit line as needed for as long as they live in the home.
If taken early in retirement and left to “grow” for several years, a reverse mortgage line of credit can serve as a buffer . . . when they face market turmoil and negative returns.
If taken early in retirement and left to “grow” for several years, a reverse mortgage line of credit can serve as a buffer that prevents retirees from drawing on their investment portfolios in years when they face market turmoil and negative returns.
Coordinating draws from a reverse mortgage line of credit reduces the strain on investment portfolio withdrawals, writes Pfau, who published an extensive research paper detailing the various strategies in which a reverse mortgage can be used in retirement income planning.
“Retirees are more exposed to investment volatility because volatility has a bigger impact on financial outcomes when taking distributions from the portfolio as compared with when adding new funds to the portfolio,” Pfau says. “Reverse mortgages provide a buffer asset to sidestep the sequence risk by providing an alternative source of spending after market declines.”
A reverse mortgage line of credit can also provide other potential benefits for borrowers if obtained early in retirement.
The second potential benefit for opening a reverse mortgage early, especially when interest rates are low, is that the principal limit a borrower can draw from will continue to grow throughout retirement, according to Pfau.
Most of the reverse mortgages found on the market today are insured by the Federal Housing Administration. Known as Home Equity Conversion Mortgages (HECMs), the government backing makes reverse mortgages non-recourse loans. This means that if the reverse mortgage loan balance grows to be larger than your home value, you will never be required to pay more than the home is worth at the time of sale.
Because you will never be on the hook for more than your house is worth, this non-recourse provision can benefit borrowers who end up living longer lifetimes, granted they continue to live in the home as their principal residence. Vacating the home for any reason for longer than 12 months triggers the reverse mortgage to become due and payable.
Borrowers may particularly benefit from the non-recourse provision if they obtain a line of credit and manage to live long enough where the balance in the credit line has grown to exceed the value of their home.
“. . . for sufficiently long retirements, there is a reasonable possibility that the line of credit may grow to be larger than the value of the home . . . .”