How a reverse mortgage can ease homeowners' retirement

Many homeowners today choose to retire, or are obliged to, before they have fully paid off their mortgages. With their incomes reduced, the required monthly mortgage payments can become burdensome.

If a balance is not too large relative to the value of the home, it can be paid off with the proceeds of a home equity conversion mortgage (HECM), the reverse mortgage offered by the Federal Housing Administration, which has no required payment.

If the borrower is 62, the balance of the old mortgage cannot exceed 50 percent of the value of the home; the cutoff rises to about 68 percent for a borrower age 87.

The conversion of a standard mortgage to a reverse mortgage is not for everyone. But there are ways in which it may offer an advantage.

Use an HECM to delay taking Social Security. For most seniors, waiting until age 70 before collecting Social Security, as opposed to taking a smaller amount earlier, is an excellent investment. A senior who could draw $1,350 a month at age 62 would see the draw increase to $2,376 at age 70.

Yet more than two of every three workers eligible for Social Security take it early. One major reason is that they are short of income. This can be remedied if they are homeowners with equity.

Not that much equity is needed. If the borrower is 62, a monthly payment of $1,000 covering the eight years until age 70 is available with equity of $155,000. At age 67, when the payment term is only three years, the required equity is only $66,000. If the borrower has more equity than is needed, all the better - it can be drawn on as needs.

Increase monthly income during your lifetime in house. The most straightforward remedy for inadequate income is what is called a "tenure" payment, which is a monthly payment that runs as long as the borrower resides in the house.

A tenure payment can be converted into a credit line at any time, and if the recipient dies early, substantial equity remains for the estate. On the other hand, if the recipient must move permanently to a nursing home, the tenure payment will stop.

Tenure payments vary with the property value, the borrower's age, and interest rates when the mortgage is taken out. On March 11, for example, the tenure payment ranged from $266 for a borrower of 62 with a house worth $100,000, to $2,582 for a borrower of 87 with a house worth $400,000.

Accumulate a financial reserve as protection against the risk of outliving your money. Seniors who accumulate nest eggs during their work years that they then use to maintain their lifestyles during retirement may be at risk of running out of money if they live too long.

Even if the probability of that happening is low, no one wants to live with the prospect of becoming destitute. Seniors who own homes, however, have a way to guard against that outcome. If they take a HECM credit line and let it sit unused, the line grows over time - the longer they live in their house, the larger will be their unused line.

For example, a senior of 62 with a house worth $200,000 qualifies for an initial HECM credit line of $48,000. If interest rates remain stable, the line will grow to $157,000 in 20 years.

If interest rates increase and the borrower selected an adjustable-rate mortgage with a 5 percent rate adjustment cap, the line in 20 years would be $355,000. If the borrower had selected an ARM with a 10 percent adjustment cap and rates increase by the maximum allowed, the line after 20 years would be $752,000.

Downsize by purchasing a house using an HECM to minimize asset liquidation. Many home purchasers are seniors who already own homes but want a change. They may want a house in a different location, and in many cases they want to downsize, both the physical house and the financial burdens that come with it.

A HECM reverse mortgage can facilitate this process by funding part of the cost, which reduces the need to liquidate other assets without imposing a monthly payment.

For example, a 62-year-old purchasing a $200,000 home could obtain up to $98,375 with an HECM. This reduces the amount that must be obtained from asset liquidation and other sources to $101,625. A purchaser age 82 could obtain up to $128,375 with an HECM, reducing asset liquidation to $71,625.

At my website, http://www.mtgprofessor.com, are tables that illustrate each of the uses of an HECM in greater detail. You can also find the values for your particular situation using my HECM calculator.

Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.