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A Reverse Mortgage Can Be Smart Investment

Reverse mortgages, or home equity conversion mortgages, are touted as a way for homeowners live longer and more affordably in their homes.

And while most seniors do so out of necessity, a reverse mortgage can also be part of an investment strategy or insurance policy that extends retirement savings, provides income tax-free and keeps you in the home, experts say.

It can be a great fit if you don't want to pass on your home to heirs.

"A reverse mortgage can act as a personal hedge fund," says Greg Cook, vice president of Reverse Lending Experts, an advisory firm in California. "A reverse mortgage when used with discretion can actually help maintain other investments ... when paying for those unforeseen expenses that happen in everyone's life."

[Read: How to Profit from Your Biggest Investment.]

Reverse mortgages should be approached with caution, however, since they often limit "future funding prospects and access to additional home equity for retirees," says Sahil Gupta, co-founder and CEO of Patch Homes, a private home lender that offers reverse mortgage alternatives.

And ultimately, a reverse mortgage is still debt, says Neil Krishnaswamy, a certified financial planner at Exencial Wealth Advisors in Frisco, Texas.

"But unlike most other forms of debt, payback is optional and that provides significant flexibility for cash flow planning," Krishnaswamy says.

Before making a reverse mortgage part of your plan, ask yourself the following questions:

How much do I owe on my mortgage? Homeowners considering a reverse mortgage should have a very low mortgage balance or own their homes outright, Gupta says. This helps maximize the payout amount for living expenses and other needs. You won't be able to take out any more equity after this, so get as much as you can upfront, he says.

By taking a reverse mortgage as soon as you are eligible, you can accumulate a greater share of equity over time, which can be used to improve the longevity of the retiree's income, Cook says.

Even if you have plenty of savings and have paid off your mortgage, a reverse mortgage could be set up with a reserve account, says Brian Saranovitz, co-founder of Your Retirement Advisor in Massachusetts. That way, you tap it when you need it, it grows slowly over time, and it can be used for many purposes, including an income buffer when the investment portfolio loses value in a downturn, a long-term care fund, an emergency fund, or a last resort fund.

What is your tax situation? Because income from a reverse mortgage is tax-free, it can be used to extend your savings into retirement, particularly for those who would also like to do partial annual Roth IRA conversions (Roth IRAs are funded with after-tax money) before age 70.5 when IRS-required distributions begin, Krishnaswamy says.

[See: 7 Things That Can Derail Your Retirement Investing.]

"But depending on the size of Roth conversion done, it can also be a squeeze to come up with the cash to pay the resulting tax bill. Using a reverse mortgage line of credit or term payment feature [to pay the taxes] can be one way to solve this problem," he says.

Do you need a bridge to Social Security? It is often advantageous for people to claim Social Security benefits later, but that income gap often needs to be met by taking higher withdrawals from personal investments.

"One could choose to carve out a portion of their portfolio to create this income. But in our lower interest rate environment, that can turn out to be an unrealistically high dollar amount," Krishnaswamy says. "It could simply be more efficient to use a reverse mortgage term payment to create a similar income stream."

Is your portfolio risk diversified? A reverse mortgage can help hedge downward fluctuation in the real estate and stock markets.

A homeowner is never responsible for more than 95 percent of the home's market value. A surviving spouse or heirs are not responsible for a negative account balance upon the retiree's death, Saranovitz says.

A reverse mortgage line of credit can also be accessed to provide liquidity for spending during down-market years, Krishnaswamy says, meaning you would not be forced to sell investments at inopportune times.

"This flexibility can be especially helpful in the early years of retirement as poor returns during these years can be more stressful with a traditional portfolio withdrawal strategy," he says.

The upfront costs of reverse mortgages are high and have risen significantly in the last year, Krishnaswamy adds.

It works like this: a bank offers a homeowner who is at least 62 years old a lump sum payment, payments over a period of time or a line of credit in exchange for the home's equity -- with interest on the loan -- when he or she no longer lives there.

[See: 10 Investing Themes to Remember for 2018.]

Before signing on the dotted line for any financial product, allow a qualified financial advisor or tax specialist to evaluate it, Krishnaswamy says.

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