Many homeowners near or in retirement are in the enviable position of owing little or nothing on the old homestead, often making the home their largest investment. That leaves a pile of home equity to tap that can be invested to help with expenses.
But what's the best way? Generally, homeowners have two choices: downsize -- selling the home and buying a cheaper one; or taking out a reverse mortgage -- a loan that need not be repaid until the home is sold.
Like most financial matters, the best choice depends on the individual homeowner's circumstances. How solid are other income sources? How well could downsizing proceeds be invested to produce income? Does the homeowner want to leave assets to heirs? And, of course, what's the owner's health and life expectancy?
Kevin Godfrey, owner of Henry Laurent Estate Sales, a Great Neck, New York, firm that helps clients liquidate estates, says many wrestle with the choice but that nine out of 10 choose downsizing. That may be because the Long Island housing market has been so good for long-term homeowners.
Houses that sold 40 years ago for $65,000 are now selling for more than $1 million, he says.
"They would rather take these funds and retire comfortably out of state and be able to provide their heirs an inheritance than simply stay in the house for the sake of convenience," Godfrey says.
He says many owners have been free of mortgage payments for many years and just don't want to take on a new debt with a reverse mortgage.
Downsizing is straightforward. Sell the old home for $400,000 and buy a new one for $250,000, then put the remaining $150,000 to work -- spend it gradually or invest in securities that pay interest or dividends, or buy an annuity that will provide a steady income for life.
In a downsizing, the owners have complete control over the cash left after the new home is purchased. They can spend it, invest it, pass it to family members -- whatever they like.
Also, the owners can extract all the equity from the old home, while a reverse mortgage may free up only half.
But, of course, there's no guarantee how long that cash-from-equity will last, unless it's put into an annuity that will pay income for life.
Michael R. Dinich, founder of Your Money Matters, a website providing financial advice for retirees, says the math often does not favor downsizing, because the new property often takes all or nearly all the proceeds from the old one.
"Usually, the only way to come out ahead is to take a substantial reduction in living conditions," Dinich says.
A reverse mortgage is an alternative. It means taking out a government-backed loan against the home. There are no monthly payments on this type of loan. Instead, interest charges are added to the loan balance and the entire debt is paid off when the home is sold or no longer used as the primary residence. The lender cannot force a sale even if the debt grows larger than the property's value. Nor can it go after other assets -- the homeowner cannot be forced to pay back more than the home fetches.
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A key advantage over downsizing: you won't outlive your money. Those who opt for a monthly income from the proceeds, rather than a lump sum, are guaranteed that income for life, even if the debt becomes larger than the home's value. That's where the federal guarantee comes in -- a kind of insurance protecting the lender. The proceeds can also be taken as a line of credit that, if used carefully, can also last for life, as it will grow over time.
Dinich says a reverse mortgage can work better than downsizing by providing dependable income.
"These monthly payments could be used to enhance the client's quality of life while keeping them in the home they know, whereas in selling the home the proceeds are consumed to provide for housing expenses," he says.
But Scott Hanson, co-founder of Hanson McClain Advisors in Sacramento, California, says many clients shy away from a reverse mortgage.
"There is still some fear when it comes to reverse mortgages, although the industry has changed a lot," he says. "When it comes to reverse mortgages, there's a fear of the high fees that used to be associated with them, which can still be the case if you don't shop around to find low-cost options, as well as the fear of not having anything to pass along to their heirs. I have some reservations as well and honestly believe a reverse mortgage should be the last option."
Another downside: To reduce the risk of the debt growing larger than the home's value, the loan is limited to less than the home's full value. For a borrower taking out a reverse mortgage at 62, the youngest allowed, the loan might be only half the appraised value.
Also, as interest charges are added to the debt, the homeowner accumulates interest upon interest. The debt may snowball until there is no equity left in the home, even if the loan was far less than the property value at the start. Then there would be no asset to tap later or to leave to heirs. Upon the homeowner's death, the home would be sold to pay the debt.
A reverse mortgage can turn out badly if poor health or other problems forced the owners from the property. Once it is no longer the primary residence, other assets or the home would have to be sold to pay off the debt, and the income stream would end.
"If someone does a reverse mortgage, they've got to be pretty darn sure that it's going to be the last house they're ever going to live in," Hanson says.
Also, he adds, "My screening process includes making sure clients considering reverse mortgages show no desire for their home to be inherited."
It's a tricky decision, and most experts recommend professional help. In fact, the applicant must talk to a government-approved consultant before taking out a reverse mortgage.
Dinich says non-economic factors like an attachment to the home or a desire to live near family often drive the decision.
"It has been my experience that the non-economic (issues) factor into the decision more than the financials," he says. "As such, I always advise my clients when considering a reverse mortgage or sale to move slow, take your time, ask lots of questions and discuss it with their children."
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