Two benefits give opening a reverse mortgage earlier in retirement the potential to improve retirement efficiencies in spite of loan costs. First, coordinating withdrawals from a reverse mortgage reduces strain on portfolio withdrawals, which helps manage sequence of returns risk. Investment volatility is amplified by sequence of returns risk and can be more harmful to retirees who are withdrawing from, rather than contributing to their portfolio. Reverse mortgages sidestep this sequence risk by providing an alternative source of spending after market declines.
The second potential benefit of opening the reverse mortgage early—especially when interest rates are low—is that the principal limit that can be borrowed from will continue to grow throughout retirement. Reverse mortgages are non-recourse loans, meaning that even if the loan balance is greater than the subsequent home value, the borrower does not have to repay more than their home is worth. Sufficiently long retirements carry a reasonable possibility that the available credit may eventually exceed the value of the home. In these cases, mortgage insurance premiums paid to the government are used to make sure the lender does not experience a loss. In addition, the borrower and/or estate will not be on the hook for repaying more than the value of the home when the loan becomes due. This line of credit growth is one of the most important and confusing aspects of reverse mortgages.
As the government continues to strengthen the rules and regulations for reverse mortgages and new research continues to pave the way with an agnostic view of their role, reverse mortgages may become much more common in the coming years. Many Americans rely on home equity and Social Security as the two primary available retirement assets.
Wade D. Pfau, Ph.D., CFA, is a professor of retirement income in the Ph.D. program in financial services and retirement planning at The American College in Bryn Mawr, Pa. He will speak on reverse mortgages at Financial Advisor's Inside Retirement conference in Dallas on May 11. He is also a principal and director at McLean Asset Management and the chief planning scientist for inStream Solutions. He actively blogs at RetirementResearcher.com.