Reverse mortgages are enormously unpopular in the U.S., with less than 2% of eligible borrowers taking up the products in most years, according to one study. Consumers are rightly skeptical, given high up-front fees and elevated foreclosure rates.
But reverse mortgages are also one of the more promising ways to protect against both falling home prices and outliving assets. And they can be a lifeline for retirees with a lot of home equity and not much else.
Challenging your property taxes
Reverse mortgages are loans taken out by homeowners (all at once or over time) with their home as collateral. As opposed to home equity lines of credit or traditional mortgages, the homeowners don’t pay anything until they die or their house is sold.
One of the key characteristics about the loans is that they are “nonrecourse” products—meaning that homeowners don’t have to pay back any balance if it’s more than the value of their home. Let’s say, for example, that the owner of $400,000 home takes out a $200,000 reverse mortgage on their 65th birthday with a 4% interest rate. After 25 years, they’ll owe about $535,000 on the loan. But because of the nonrecourse feature, they are off the hook from owing any amount over the value of the house. If their $400,000 home didn’t appreciate, that’s a $135,000 windfall.
This nonrecourse feature is potentially worth a lot to homeowners, especially if they use it exclusively as protection against a falling value of a home. Under this “ruthless” strategy (as economists have dubbed it), borrowers initiate a mortgage, but don’t actually borrow any money unless the value of their home falls. This way, borrowers only pay a few thousand in up-front fees, but cash in if their home’s value falls.
This strategy is rare despite its theoretical appeal. A while ago, economists Thomas Davidoff and Jake Wetzel found that “close to zero percent of borrowers” used the ruthless strategy. But it can be valuable for those who do: MIT economist Deborah Lucas found that the average value of a reverse mortgage for a ruthless borrower is $53,000.
Even for retirees who don’t find this strategy appealing, the lesson is that reverse mortgages can be a valuable way to protect against a dip in home value—which is the primary asset for many retirees. And because homeowners can stay in their homes indefinitely (as long as they maintain it and pay their taxes), reverse mortgages can be a sound way to protect against outliving your assets—a bit like buying an annuity that pays your rent every month for as long as you live.
There are lots of caveats. Lenders can foreclose on a home if borrowers don’t pay their taxes. The interest rates on the loans are probably too high given the limited risk taken by lenders. These loans are a poor choice for people hoping to leave a house to their kids. And, perhaps most importantly, these loans can cost consumers thousands in fees if they sell the home a few years after taking out the loan.
But reverse mortgages are also a unique way to take the risk out of retirement, and can be worth thousands to borrowers willing to take a strategic approach to borrowing. For retirees worried about falling home prices or outliving their assets, this product may be worth a look.
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