According to a new research report from The American College of Financial Services,Americans moving into retirement don’t have a good understanding of how to effectively use home equity as an income source in retirement. The report surveyed over 1,000 people aged 55-72 with at least $100,000 in investable assets and $100,000 in home equity to determine their feelings on housing in retirement and test their knowledge with a 10-question true or false literacy quiz on reverse mortgages, which can be taken here.
The average score was 48% with 10% of respondents unable to answer a single question correctly. While not overly surprising, this lack of reverse mortgage literacy amongst those around retirement age is a bit alarming as home equity is the primary source of wealth for the average 65-year-old American couple. It is therefore imperative that one understands how to properly utilize it, which requires making informed decisions. Let’s now examine the top three misconceptions that Americans seem to have about reverse mortgages.
1) Can you owe more than your home is worth? Only 25% of respondents knew that if your home goes under water, you do not need to pay off the additional debt as the loan is a nonrecourse loan. Almost all reverse mortgages are insured by the Federal Housing Administration under a program called the Home Equity Conversion Mortgage program. Through an FHA insured HECM loan, the FHA basically pays off any loan balance above the sale price of the home so that neither the heirs nor the homeowner will owe more than the home is worth.
2) When is the best time to use a reverse mortgage? Only 27% of respondents knew that using a reverse mortgage early in retirement tends to be better than using it as a last resort towards the end of retirement. Research has consistently shown that strategic uses of reverse mortgages can be used to improve a retiree’s financial situation, and that reverse mortgages generally provide more strategic benefits when used early in retirement as opposed to being used as a last resort. Reverse mortgages can be used as a bridge to delay Social Security, as a tax planning tool to keep tax rates lower, and as a non-market correlated asset that can be tapped into when a retiree’s investments are down in value to reduce sequence of returns risk in retirement. Additionally, even the regulatory body FINRA has also removed the “last resort” language when referring to the strategic uses of reverse mortgages.
3) At what age can you enter into a reverse mortgage? Only 38% of respondents knew that age 62 is the earliest age at which the sole owner of a home can enter into a reverse mortgage. Knowing when you can engage in a reverse mortgage is important as most of the research surrounding the strategic uses of reverse mortgages shows increased benefits to setting up a reverse mortgage early in retirement as opposed to late in retirement.
While the survey reveals a large amount of misconceptions about reverse mortgages, a good amount of respondents felt comfortable spending their home equity as an income source in retirement. That number could grow if more people take a look at home equity as an income source. Only 44% of those surveyed had ever considered home equity as an income source for retirement. If more people were to consider home equity as an income source, the resulting boom in reverse mortgages could improve the overall retirement income security of Americans.
While reverse mortgages are not for everyone, homeowners should at least consider the use of home equity as a retirement income source. However, consumer misconceptions about reverse mortgages are not the only hurdles in keeping home equity from being more effectively incorporated into retirement plans. Americans often have a strong negative bias towards reverse mortgages, which could be fueled in part by America’s lack of reverse mortgage literacy. Not nearly enough financial advisors consider home equity as part of a so-called comprehensive retirement plan. It is really not a comprehensive plan if it ignores most Americans’ largest asset – home equity.
However, this tide is starting to turn as home equity planning is showing up in more financial advisors’ plans, researchers are looking at strategic uses, and regulators are recognizing the benefits. Additionally, the new DOL conflict of interest rule, which requires advisors to provide investment advice to IRAs to act as a fiduciary, could put some pressure on incorporating, or at least considering, home equity when providing recommendations surrounding a retirement plan distribution.
The research is quite clear that strategic home equity use through reverse mortgages can substantially improve a retirement income portfolio. Ultimately, Americans are facing severe retirement funding issues and will need to be better informed about their planning options, including reverse mortgages and home equity, if they hope to enjoy a financially secure retirement.