As the amount of home equity available to seniors continues to rise while issues in American retirement keep mounting, using the home equity available to a senior through the use of a financial tool like a reverse mortgage may be a reasonable and viable solution to explore for someone looking to get access to additional cash while aging in place. This is according to Shelley Giordano, co-founder of the Academy for Home Equity in Financial Planning at the University of Illinois Urbana-Champaign in a new column at The Street.
One problem with relying on home equity in retirement, Giordano says, is that there are only two primary options: moving out of the existing home and downsizing into a home that could be smaller, or borrowing against the home’s value.
“Moving is both emotionally and financially expensive and many homeowners dismiss a move outright,” she says. “Yet borrowing against the home is fraught with income and credit constraints and puts the borrower at risk if they’re unable to continue making monthly principal and interest payments, keep the house maintained and insured, and stay current on property taxes.”
However in spite of some of these risks, many older homeowners are turning to their home’s equity to help finance retirement according to a research paper published at the Wharton Pension Research Council.
“[T]he authors report that seniors are using relatively high loan to value (LTV) loans of 57-65%,” she says. “This is especially high considering that many of these mortgages ‘require payments lasting decades into retirement’ that ‘rise’ in relation to declining assets as the borrowers age.”
Traditional approaches for those with the means including the employment of a home equity line of credit (HELOC), but required monthly interest and principal payments could make the option untenable for some prospective borrowers, she says. Reverse mortgages offered prior to the 1980s were also rife with issues, but the more modern Home Equity Conversion Mortgage (HECM) lacks bank ownership and comes with the involvement of the Federal Housing Administration (FHA), Giordano writes.
“The HECM […] allows homeowners to borrow without monthly principal and interest payments yet maintain control of their title and future home appreciation,” she writes. “Likewise, the FHA insurance provides downside protection should the home value drop – neither the borrower nor his estate will ever be required to pay back more than the fair market value of the home when the last borrower dies, moves, or sells.”
While a HECM may not be the best home equity option for a specific borrower, they are still options that merit consideration when determining the best course of retirement, Giordano says.