A recent U.S. News & World Report article described how the elderly can prepare for three different emergencies commonly faced by those of retirement age. The article didn’t mention, however, the best solution to two of the three problems: a reverse mortgage.
In this article, therefore, I will explain how a reverse mortgage can help seniors deal with major home and car repairs, steep medical bills, and the issue of outliving their savings.
Major Home and Car Repairs
Home- and auto-related expenses are seldom that big a surprise.
But those who don’t prepare for them — or procrastinate in dealing with them — may be startled on the day their roof’s drip becomes a flood or their cranky car’s engine no longer starts.
The U.S. News piece suggested that seniors maintain a cash fund capable of covering six to 12 months of expenses. This is OK — for renters.
For homeowners, however, a reverse mortgage credit line has several advantages.
First, assuming the owner has significant equity in her home, a sizable credit line will become available to her when the loan is closed. And, in order to get one, she won’t need to sock away cash for an extended period, because a reverse mortgage is based on saving the owner did in earlier years.
For example, a 65-year-old homeowner with a debt-free house worth $200,000 could obtain a line of about $100,000, which would be fully available at closing for a cost of about $8,500.
The second advantage is that the unused line of credit will grow in accordance with the interest rate on the reverse mortgage. Right now, typical interest rates are 3-5 percent. Comparatively, a cash fund would earn 1 percent or less.
While the cost on an unused line will also grow in accordance with the interest rate, the growth of the credit line — an amount much larger than the cost — will more than mitigate that issue. Using the example homeowner above, her $100,000 line, if unused for 10 years, will grow about $83,000. Over the same period, the cost will grow only $7,000.
Runaway Medical Expenses
Medical emergencies can strike out of the blue, and the costs involved are far from predictable and can be catastrophically large.
Insurance is the only way to deal with this problem.
Outliving Your Savings
Aside from suffering poor health, this is the greatest hazard faced by retirees. It’s also the hardest to guard against.
U.S. News’ suggestion that retirees delay taking Social Security until they turn 70 makes sense for those who expect to live long lives. But it won’t come close to filling a retiree’s income shortage if the major source of their income is withdrawals from savings and those savings drop to zero.
A retiree who puts off taking Social Security until at age 70 typically receives about $1,000 more per month than if he had started receiving payments at age 62.
But if the retiree is accustomed to withdrawing $4,000 a month from savings, and those savings run out, the knowledge that he would have been in even worse shape had he not delayed taking Social Security won’t do anything to help.
The reverse mortgage credit line is the ideal vehicle for insuring against the risk of outliving your money. As noted above, it grows at the mortgage rate so long as it is unused.
Should a need arise, a senior can begin drawing on the line or purchase a monthly tenure payment that will continue as long as she lives in the house.
She could also purchase a tenure payment with part of the line and retain the rest for special occasions.
If a need never arises, the unused equity in the house will pass on to the borrower’s estate.
About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.
