Tapping home equity as a component of retirement planning — by either downsizing or using a reverse mortgage — has a generally bad reputation, but that should not be the case. This is according to retirement columnist Mark Miller in a new piece published by Morningstar.
“Half of all households face the risk of a declining standard of living in retirement owing to inadequate savings, the decline of traditional pensions, and lower Social Security replacement rates,” Miller wrote. “But the majority of older Americans are homeowners—and most of these households have more home equity than financial assets.”
Miller acknowledges the role that reverse mortgages play in the predominant reputation. While reverse mortgages can have their benefits, there are other alternative options for home equity tapping that are not as widely discussed, he said.
“Households with inadequate savings stand to benefit most from tapping housing wealth, but everyone faces longevity risk—that is, the risk that you’ll outlive your savings and potentially need to lower your standard of living late in life,” he said. “Longevity risk has been a hot topic lately in the wake of the recent bout of high inflation. But inflation is always a risk to the long haul of a retirement plan.”
Housing wealth can generally serve as a hedge against inflation, especially in housing markets where values have risen and are likely to continue to rise in the months ahead. It can also assist in funding long-term care, an increasingly costly proposition for any older person not prepared to weather such costs.
With that, Miller lays out two potential options for leveraging home equity: the first is to sell the property and move — generally the most widely-used option — but the idea of borrowing against your home should not be dismissed out of hand if the occupant of a particular home does not want to move out.
“If you don’t want to move, another option is to borrow against your home equity,” he said. “Conventional mortgages and home equity lines of credit are one possibility, but the amounts you borrow must be repaid with regular monthly payments. That brings us to the reverse mortgage loan.”
Home Equity Conversion Mortgage (HECM) products are “not very popular with retirees,” Miller said, an assertion based on HECM volume data indicating just 64,437 in FY 2022. Miller also mentions his own misgivings about reverse mortgages.
“As a financial product, I don’t love reverse mortgages,” he said. “In a more perfect world, we would support the income needs of seniors through higher Social Security benefits and lower healthcare costs. Reverse loans can be difficult to understand, and they do come with high fees and some risks that have generated a lot of deserved bad press over the years.”
But like other product observers have noted, the evolving regulatory landscape governing the HECM program in particular has helped to ease some of those concerns, he said.
“Federal regulation of reverse loans has been tightened in recent years to reduce these risks,” he wrote. “And if you just don’t want to move out of your home and need the income, it is possible to use a reverse loan safely.”