Retirement often comes with liquidity and income constraints: Is a Reverse Mortgage for you?

Montecito Capital Management, a financial advisory firm serving communities in Santa Barbara and Los Angeles offers independent guidance and counsel for homeowners considering a reverse mortgage. First, there are the good, the bad and the ugly products out there, so “caveat emptor,” buyer beware. The takeaway is that some reverse mortgage providers are superior to others, the different reverse mortgage options should be tailored to each individual’s circumstances, and it is advisable to have an independent third-party professional determine whether a reverse mortgage is the right pathway.

For clarity, we are not licensed to sell reverse mortgages, are in no way in the mortgage business and do not accept (nor are licensed for) commissions, and therefore we offer conflict-free financial advice as Fiduciary advisors.

Reverse mortgages are financial products designed primarily for older homeowners, allowing them to convert a portion of their home equity into cash without having to sell their home or make monthly mortgage payments. By way of background, reverse mortgages have been around since 1961, launched by a widow, and were initially pursued by widows to live in their home and have access to funds after their spouse passed. There has since been a good amount protective legislation and consumer protection for borrowers, and therefore reverse mortgages have become more mainstream. Indeed, the myth that the lenders want to take your home isn’t really relevant given all the safeguards in place and the fact the lenders only allow 40%-60% borrowing capacity of home equity. That said, there is complexity in the type of loan options relative to the individual homeowner’s circumstances, and it is recommended you seek financial advice from a neutral third-party, such as a financial professional. Obviously, we are well-versed in this space to provide guidance and direction.

Here’s an overview of their importance, considerations, benefits, and drawbacks:

A reverse mortgage may be appropriate for those who have a considerable amount of equity in their home and plan to live there for the foreseeable future. This financial solution is particularly relevant for individuals who lack adequate retirement income and/or savings. Seniors facing substantial costs in their later years, including healthcare, inflation, or income shortfalls, might find monetizing home equity value as a viable solution.

Additionally, a reverse mortgage can also be a superior estate planning tool for heirs given a trust has been established, to where any remaining equity in the home can pass to beneficiaries after death with the 2024 benefit of the federal tax exemption in the amount is $13.61 million per individual. In contrast, should a retiree sell their home to access the equity value, any amount of gain more than the primary homeowner exclusion would be subject to capital gain taxes.[1] 

Individuals aged 62 and above may qualify for a reverse mortgage, which allows them to access funds based on the equity they have built in their property, which translates into a cash borrow opportunity for those candidates that already have substantial equity value in their home. Retirees who do not want to sell their home yet need access to additional funds to meet their lifestyle in retirement should at least consider the pros-cons of a reverse mortgage for cash needs in their golden years. Further, many in their late 60s and older are out of the work force and now have limited “earned” income, which makes it difficult for retirees to “qualify” for access to equity with a home equity loan (HELOC).

The Federal Housing Authority (“FHA”) insures a reverse mortgage known as a FHA Home Equity Conversion Mortgage (HECM). One-on-one reverse mortgage counseling is required to receive a HECM loan, and a HECM Counseling certificate is issued to counseling recipients as proof that the counseling occurred. Other reverse mortgage programs may also have counseling requirements. There is also a fairly new California law that requires a “7 day cooling off period” before a lender or broker can accept your reverse mortgage application and no fees may be assessed upon a prospective applicant until after 7-days from the date of counseling, which is technically the 8th day following counseling.

For most retirees, their home is the largest asset and for California residents, the home has delivered an impressive unrealized gain. According to realtor.com, California has one of the highest five-year homeowner appreciation returns in the country at 34%, with the 10-year being an astounding 78% return. What this also means is that should the home continue to appreciate in line with historical trends, the home equity appreciation will help offset the interest accrual on the reverse mortgage.  Indeed, the interest accumulates with the loan amount and is paid when the home is later sold, or should the homeowner, or their heir, choose to pay off that loan.

Another potential cost offset is having an income portfolio of investments from the loan proceeds that your financial advisor can implement to deliver a range of 6%-7% return. 

Retirees rely on a combination of pensions, social security and personal savings to fund their retirement. Because retirement income is often limited, it is very useful to have funds from which to cover living expenses, medical expenses and other needs. 2. Home equity can be used. 3. Age in place. By allowing the borrower to stay in his home longer, reverse mortgages allow him to stay longer in it, paying for necessary repairs or care services at home. 4. Monthly payment or credit line available. Some advantages of a reverse mortgage. 1. No monthly payments: Borrowers do not have to pay monthly mortgages, which helps them to relax their finances. 2. Non-recourse loan. Borrowers and heirs are not responsible for the value of the home after the loan is repaid. 3. Tax-free proceeds. 4. Easy payments: most of the reverse mortgage loans are not taxed as income. 4. More stable: you can get more out of it without reducing the use of the exploitation of the principal. Using the reverse mortgages in the right way helps you to be sustainable in the interest and to smoothen the waves.

Reverse Mortgages. 

Pros: 

1. Increased cash flow: Provides more income for retirees on a budget; 

2. Home ownership retained; can live in the home and still draw money from it; 

3. Living conditions improved and reduced financial stress; 

4. Stable income stream from the asset: With the help of an expert, the investment can provide a stable income from the loan which covers interest and other living costs.

Cons: 

1. The loan balance grows as interest is accumulated, reducing home equity; 

2. Costs and closing costs: Reverse mortgages may have high up-front costs like origination fees, closing costs, and mortgage insurance premiums; 

3. The encumbrance of estate: the reverse mortgage must be repaid after the death or move out of the householder, inducing heirs’ income; 

4. Eligibility requirements: Borrowers must meet criteria like age (typically 62 years), home equity, home as principal residence. 

5. Potential for Forced Foreclosure: Failure to meet the terms of payment on property taxes, insurance or maintenance threatens a breach of loan terms and a risk of foreclosure.[1] 

For singles, the exclusion is $250,000. To qualify for the capital gain exclusion, homeowners must have lived in the home as their primary residence for two out of the last five years. For joint tax spouse tax filings, this amount is up to $500,000 of that gain.

To best serve at the convenience of our clients, advisors also regularly travel within 120 mile radius of both the Central & Southern California offices to meet clients at their homes, businesses or for lunch advisory meetings at privacy-appropriate restaurants.

Prospective clients outside our region are also welcome to contact our firm.

Wealth Management Team Leader:

Kip Lytel, CFA®, MBA

Click Here to Email & schedule a no obligation complimentary initial advisory meeting & portfolio review:

SERVING SANTA BARBARA COUNTY, VENTURA COUNTY & SAN LUIS OBISPO COUNTY
Montecito Capital Management 
225 East Carrillo Street, Suite 203
Santa Barbara CA 93101
(805) 965-7955

SERVING LOS ANGELES COUNTY, SAN BERNARDINO COUNTY & ORANGE COUNTY
Montecito Capital Management 
522 S. Sepulveda Boulevard, Suite 207
Los Angeles, CA 90049
(805) 965-7955