Housing prices have taken a nose dive in most U.S. markets since the start of the recession in 2007. Almost $3 trillion worth of equity has disappeared, and homes are now worth significantly less than what many owners paid for them. This evaporation of equity has dealt a devastating blow to many elderly Americans who had planned on tapping into that equity to supplement their retirement through reverse mortgages.
The truth is that reverse mortgages shouldn't be used as a last-minute tool to fund your retirement. Unfortunately, the lack of homeowners' equity and a host of other factors have made reverse mortgages a thing of the past as a retirement option.
What is a reverse mortgage?
A reverse mortgage is much like a standard mortgage for your home. It is called a reverse mortgage because the homeowner receives a cash payment based on the amount of equity he or she has in the home. So, after you finally get the mortgage on your home paid off and you own it free and clear, you can go back into debt for the exact same house.
In contrast to a conventional mortgage, however, there is no repayment requirement as long as the homeowner meets certain requirements, such as continuing to use the home as his or her primary residence. Once the borrower dies, the loan must be repaid.
Reverse mortgages require equity
One of the biggest realizations to come out of the current housing crisis is that reverse mortgages require homeowners to have equity in their homes. If you've been banking on a reverse mortgage to fund your retirement instead of investing for your financial goals, you could be in for a rude awakening.
The recent (and ongoing) housing crisis has left many people at or near retirement in a tough situation, with little in retirement savings and instead counting on using home equity to fund their retirement dreams via a reverse mortgage. But, when the equity disappeared, so did their ability to borrow against their homes for retirement. Traditionally, homeowners thought that home prices would rise forever, but that has not been the case recently.
Reverse mortgages can hurt your heirs
When you borrow against your home equity to cover living expenses in retirement, you put your heirs at risk of serious estate-planning consequences. When you die, your reverse mortgage must be repaid. Many estates do this either with insurance proceeds or by selling the primary home that was mortgaged. This can be devastating news to family members who may have been counting on those funds. Reverse mortgages also have the potential to force the sale of homes that have been in families for generations.
Reverse mortgages aren't a substitute investing
When U.S. home prices were skyrocketing, many people skipped funding their retirement accounts in favor of buying bigger homes and paying down their mortgages. The trouble with this is that you really need a well-rounded financial plan that includes investing for retirement and other goals, saving, paying down debts, and protecting yourself and your family with insurance. Banking on the ability to borrow against the equity in your home during retirement is a risky strategy that can blow up in your face.
Reverse mortgages are expensive
Historically, reverse mortgage are expensive because of very high fees. These fees can erode the value of the equity you have built up in your home. As with all home loans, there is an origination fee, appraisal fees, closing costs, insurance, and a host of other fees that are tacked onto your reverse mortgage. Because of these fees, the cash payout that you receive in this depressed housing market will be even further reduced.
In the final analysis, there's no better alternative to investing for retirement than a well-balanced portfolio of stocks, bonds, and/or mutual funds. Using your home as a way to fund your retirement dreams is fraught with potential drawbacks, and the expectation that you'll have sufficient equity at retirement is based on the faulty assumption that your home will necessarily increase in value, or at least retain its current value.
