Reverse Mortgage or Downsize – Which is Better?
Charles and Deborah have been semi-retired for a few years and are ready to call their professional lives complete. They really want to do some traveling while they are still healthy and energetic. The only problem? They are concerned about depleting their savings. They have heard about reverse mortgages and wonder if that might be a good way to use some of the equity they have in their home without having to sell the house. They’ve also heard there are serious downsides to reverse mortgages? What should they do?
Charles and Deborah are not alone. Many retirees are concerned about their financial situation and wonder how to best manage what is often a family’s most significant asset—their home. The decision usually comes down to two options: reverse mortgage or downsize. Both have advantages and disadvantages, and one, the reverse mortgage, has traditionally been very unpopular with financial experts. Let’s look at some differences between the two.
Reverse Mortgage. First, let’s define what a reverse mortgage is. A reverse mortgage, also known as a Home Equity Conversion Mortgage (HECM), is a special type of home loan that lets you convert a portion of the equity in your home into cash. According to the U.S. Department of Housing and Urban Development (HUD), an HECM is “a safe plan that can give older Americans greater financial security.”
Seniors may use a reverse mortgage to supplement Social Security, meet unexpected medical expenses, or make home improvements, according to the HUD website.
To be eligible for an HECM backed by the Federal Housing Authority (FHA), a homeowner must be 62 years old or older and either own their home outright or have a low mortgage balance that can be paid off at closing with the balance of the proceeds from the reverse mortgage. The homeowner also must have the financial resources to pay ongoing property charges, including taxes and insurance, and must live in the home. Homeowners must also receive low-cost credit counseling prior to approval. HECM borrowers do not have to repay the loan until they no longer use the home as their principal residence or fail to meet the obligations of the mortgage.
Like a home equity loan, an HECM loan acquires interest. The difference is that the borrower does not pay the interest or payments. Instead, the borrower receives payment. Eventually, when the home is sold or no longer used as a primary residence, the loan amount plus accrued interest and finance charges must be repaid. Heirs can use cash assets (like life insurance payouts or savings) or sell the house to pay off the loan, or they can turn the house over to the lender.
The reverse mortgage has earned a poor reputation over the years because many homeowners have found themselves paying high fees in the form of closing costs, loan and insurance fees, and fees for mandatory credit counseling that is required before a reverse mortgage can be completed.
Financial expert Dave Ramsey has long counseled against reverse mortgages, noting that interest accrues on the loan and the homeowner is still responsible for property taxes, insurance, and the cost of maintaining the home.
Ramsey says it is better to live more simply (and less expensively) or to sell the home and choose a more affordable housing option in order to maximize retirement dollars.
Financial writer Jane Bryant Quinn used to give the same advice, but in her most recent book, How to Make Your Money Last, Quinn included reverse mortgages as an option for seniors. In an interview with ReverseMortgageDaily.com, Quinn said that new regulations on the controversial loans made her feel better about their use.
“The fact that older people are now being protected from themselves, or aggressive sales people who might inappropriately tell them to take out a lump sum when they’re 80, only to find out they ran through the money and are now stuck—that should not happen anymore with these rules,” Quinn was quoted as saying.
Quinn cautioned that reverse mortgages are only appropriate for homeowners who intend to stay in their homes for 15-20 years because like a traditional mortgage, interest expenses are amortized upfront. And as with any financial product, a reverse mortgage should be thoroughly researched, as each individual situation is different.
Downsizing. Ramsey is still not a fan of reverse mortgages, in part because he says that most American families could downsize their home and still maintain their current standard of living. He cites statistics that show the average new single-family home today is more than double the average home size in 1950.
“Moving into a smaller home may feel like a step down, but a closer look reveals quite a few upsides,” Ramsey says.
The biggest reason to downsize is the financial savings, especially for those who are still paying a mortgage. Spending less each month on mortgage payments means more money to put toward paying off other debt or, for those who are debt-free, enjoying vacations, recreation, or long-term security with the extra cash.
Living in less space also means less time and money spent on upkeep. Downsizing is also an opportunity to get rid of clutter that takes up precious time and money as well.
Clearing out clutter is not easy, however, for the homeowner who is downsizing or for their adult children. Paula Spencer Scott, a writer for Caring.com, a website for caregivers of aging parents, spouses, and other loved ones, says that helping a parent downsize can be complicated because they are going to see “treasures, essentials, and a lifetime of memories.” The process is very stressful, which is why Scott offers tips to make the process easier in her article “20 Tips to Help You Get Rid of Junk.”
Here are three of our favorite tips from Scott’s article:
1. Avoid tackling the whole house in one go.
Though it’s more efficient for you to plow full steam ahead, your parent is apt to be stressed emotionally, if not also physically. When organizing a parent’s move, it’s better to think in terms of months, not days. Tackle one room or area at a time, and stop after two hours.
2. Use the new space as a guide.
Measure exactly how much closet or cabinet space the new place has (assisted living communities will provide this information if you ask), and fill an equivalent amount of space as you sort. Mark off the comparable space so your parent has a visual guide.
3. Be creative when it comes to favored items.
Photos, memorabilia, and collections typically take up far more space than the average assisted-living quarters can accommodate. Many services digitize images and papers for you for reasonable prices—sell the idea to your parent that every family member will get a copy, too. Keep a few favorite collectibles, then photograph the rest and present them in a special book. It’s not the same, Scott says, but it’s a space-saving way for a collector to continue enjoying.
And if you decide that downsizing is the right decision for you, Duffey Realty is here to help. Our experienced REALTORs are ready to help you sell your current home and find a home that meets your current needs. Contact us today.