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How a Reverse Mortgage Can Extend the Life of Your Financial Portfolio

Live Better Financial
Senior couple look at financial portfolio online
Senior couple looking at finances

Financial stability is crucial in retirement. Many retirees rely on their savings, investments, and Social Security benefits to cover their living expenses. However, there are times when these sources may not be sufficient, especially with the increasing costs of healthcare, inflation, and unexpected expenses. One financial tool that can help extend the life of your financial portfolio is a reverse mortgage, specifically a Home Equity Conversion Mortgage (HECM).


Understanding HECM/Reverse Mortgages


A HECM, also known as the new, government-insured reverse mortgage, allows homeowners aged 62 or older to convert part of their home equity into cash without having to sell their home or make monthly mortgage payments. The most common type is the HECM, insured by the Federal Housing Administration (FHA). The loan is repaid when the homeowner sells the home, moves out permanently, or passes away. 


Since 2017, significant changes have been made to reverse mortgages, specifically to the Home Equity Conversion Mortgage (HECM) program, which is insured by the Federal Housing Administration (FHA). These changes were implemented to ensure the reverse program's financial stability and to protect borrowers and taxpayers from potential market fluctuations and the risk of default.


New Regulations that Protect Equity


  • Lender origination was capped at $6,000

  • Annual mortgage insurance was lowered by 60%

  • Interest rates were significantly lowered

  • The amount seniors can borrow was reduced

As a result, 90% of seniors pass with positive equity in their homes, and typically more equity than when they took out the HECM.


Let's explore 7 ways that a HECM line of credit can bolster your financial plan and ensure a more secure retirement.



1. Supplement Retirement Income


One of the primary ways a HECM Line of Credit can extend the life of your financial portfolio is by supplementing your retirement income. Retirees often rely on Social Security, pensions, and withdrawals from retirement accounts. However, these sources may not always be sufficient to cover all expenses.  Converting a small portion of home equity into monthly cash flow can make a huge difference.


Example:


John and Mary are retired homeowners with a significant portion of their net worth tied up in their home. They have a modest pension and Social Security income, but it’s barely enough to cover their monthly expenses. By taking out a HECM Line of Credit, they can receive additional monthly payments, which provides them with extra cash flow to cover living expenses without depleting their investment portfolio.


According to a 2021 study by the Center for Retirement Research, approximately 50% of retirees rely heavily on Social Security benefits for their income, which often isn’t enough to cover all living expenses. A HECM Line of Credit can help bridge this gap by providing an additional income stream.

2. Reduce Withdrawals from Retirement Accounts


Drawing from a HECM Line of Credit can minimize withdrawals from retirement accounts, such as IRAs or 401(k)s, which will help prolong the life of your retirement portfolio. 


Example:


Sarah is a retiree who needs to withdraw $20,000 annually from her IRA to meet her living expenses. By using a HECM Line of Credit, she can reduce her withdrawals to $10,000 annually. This strategy allows her investments to grow and recover during market upswings, thus extending the longevity of her portfolio.


3. Provide a Buffer During Market Downturns


Market volatility can pose a significant risk to retirees, especially those who rely heavily on their investment portfolios for income. During market downturns, selling investments to cover expenses can lock in losses and reduce the portfolio's growth potential.


Example:


David and Lisa are retired and depend on their investment portfolio for income. During a market downturn, they face the risk of selling investments at a loss to meet their expenses. By establishing a HECM Line of Credit, they can draw on their home equity instead of selling investments during a bear market. This buffer allows their portfolio to recover when the market rebounds.


A 2020 study by the American College of Financial Services showed that using a reverse mortgage line of credit during market downturns can improve portfolio sustainability by up to 20%.

The Sequence of Returns Risk can drastically affect retirees' savings. A 2020 study by Morningstar found that reducing withdrawals during market downturns can add five to ten years to the lifespan of a retirement portfolio.


4. Delay Social Security Benefits


Delaying Social Security benefits can significantly increase your monthly benefit amount. A HECM Line of Credit can provide the financial support needed to delay claiming Social Security, allowing you to maximize your benefits.


Example:


Karen, 62, is considering taking her Social Security benefits early, which would reduce her monthly benefit amount. Instead, she takes out a reverse mortgage to cover her expenses for a few years. By delaying her Social Security benefits until age 70, she increases her monthly benefit by about 8% per year of delay, resulting in a much higher lifetime benefit.


According to the Social Security Administration, delaying benefits from age 62 to 70 can result in a 76% increase in monthly benefits.

5. Cover Healthcare and Long-Term Care Costs


Healthcare and long-term care costs are major concerns for retirees. HECM Line of Credit can provide the necessary funds to cover these expenses without draining other assets.


Example:


Tom and Susan are retired and worried about potential healthcare costs. They decide to use a HECM Line of Credit specifically for medical expenses. This dedicated fund ensures they have the resources to cover unexpected healthcare costs without impacting their other financial assets.  In addition, the unused portion of the line of credit will continue to grow each year, giving them access to more tax-free cash in the future.


The U.S. Department of Health and Human Services estimates that 70% of people over age 65 will need some form of long-term care, with costs averaging $105,850 annually for a private room in a nursing home.

6. Support Home Modifications and Aging in Place


Many retirees (88%) prefer to age in place, which may require home modifications to accommodate changing physical needs. A HECM can finance these modifications, allowing you to stay in your home comfortably and safely.


Example:


Bill and Carol want to remodel their home to include a walk-in shower, wheelchair ramps, and other aging-in-place features. They use a HECM to fund these modifications, ensuring their home remains suitable as they age without dipping into their retirement savings.


According to AARP, 76% of Americans aged 50 and older prefer to age in place. Depending on the extent of the renovations, home modifications can cost between $10,000 and $100,000.

7. Reduce Tax Liability


Withdrawing from a retirement portfolio can trigger significant federal and state taxes, often as high as 30% combined. Compare that to a HECM Line of Credit, where the interest rates are hovering around 7.5%. Utilizing home equity as a source of cash flow can be a much more tax-efficient way to raise capital, thus allowing the portfolio to continue growing.


Example:


John switched from withdrawing from his retirement portfolio to his HECM Line of Credit to supplement his income. This strategy helps him significantly save on taxes and increases his portfolio longevity.


The Internal Revenue Service (IRS) classifies HECM proceeds as loan advances, making them non-taxable. This can be a significant advantage for managing retirement income.


Considerations and Risks


While a HECM offers many benefits, it’s important to understand the potential risks and considerations:


  • Costs and Fees: HECM mortgages come with upfront costs, such as origination fees, closing costs, and mortgage insurance premiums. These costs must be considered when evaluating if this is the best solution.

  • Impact on Inheritance: Using home equity may mean there is less equity available for your heirs. It’s important to understand the numbers and discuss this with your family.

  • Loan Repayment: The loan must be repaid when you sell the home, move out, or pass away. If the loan balance exceeds the home's value, FHA insurance covers the difference, protecting your heirs from owing more than the home's worth.

  • Ongoing Obligations: You must continue to pay property taxes, homeowners insurance, and maintenance costs. Failure to meet these obligations can lead to loan default and potential foreclosure.


Conclusion


A HECM can be a powerful tool for extending the life of your financial portfolio. It can provide additional income, reduce withdrawals from retirement accounts, reduce taxes, and offer a buffer during market downturns. By carefully integrating a HECM into your overall financial plan, you can enhance your retirement security and maintain financial independence. 


As with any financial decision, it’s essential to consult with financial advisors and HUD-approved reverse mortgage counselors to ensure that a reverse mortgage aligns with your goals and needs. With proper planning and consideration, a HECM can help you enjoy a more comfortable and financially stable retirement.


Learn more about the new reverse mortgage (HECM) at www.livebetterfinancial.com/reverse


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