Reverse mortgages can be a productive use of home equity for many American households, but no retirement strategy is perfect for everyone and there are some risks retirees should understand before getting a Home Equity Conversion Mortgage (HECM), suggests one fee-only financial planner in a recent blog post.
Dirk Cotton, who has researched and published papers on retirement finance and regularly covers reverse mortgages on his blog The Retirement Cafe, looks at the possible HECM risks for retirees through the viewpoint of a more complex perspective that goes beyond simply providing a list of reverse mortgage “cons.”
Rather, Cotton tackles the subject within the context of retirement planning and the circumstances that could pose risks for retirees, given their financial situation and obligations as a HECM borrower.
One possible risk he mentions is that a HECM does not guarantee retirees can keep their home.
“A HECM guarantees that you can keep your home for as long as you, a spouse or a non-borrowing spouse still live in it,” he writes. “It also guarantees that you can’t owe more when you repay the loan than could be recovered by you selling the home at fair market value.”
While HECMs provide the opportunity for borrowers, their estate or even their heirs, to pay off the loan with other assets and keep the home, Cotton writes, they do not guarantee that the borrowers will have the financial means to do so.
Another potential risk Cotton relays is that a forced repayment can happen at the “worst possible time.” Repayment of a HECM typically occurs when the borrower dies, moves from the home or can no longer afford the cost of the home.
In a previous work, Cotton explained that elder bankruptcies are usually the result of expense shocks rather than poor investment results. Unexpected and interconnected events, such as the loss of a job or the incurrence sizable medical costs, only make matters worse for a retiree and can have an adverse affect on their HECM borrowing.
“If those interconnected problems also result in a HECM borrower needing to move out of an expensive home to stabilize her finances, her HECM will need to be paid back at the worst possible time—during an ongoing financial crisis—and may accelerate the downward spiral,” he writes.
Cotton acknowledges that it is also possible that a HECM might stabilize the downward spiral and save the retiree’s finances. But when credit is not adequate, however, the forced repayment could accelerate the spiral.
Read the rest of Cotton’s reverse mortgage risks at The Retirement Cafe here.
Written by Jason Oliva