In Defense of Reverse Mortgages

Critics say reverse mortgages, which allow seniors to tap their home equity for income while remaining in their homes, aren't for everyone, with high fees and a history of shady practices by some lenders. But others say that, when used responsibly, reverse mortgages can be a valuable addition to a retiree's financial tool kit. Alicia Munnell, director of the Center for Retirement Research at Boston College, recently spoke to Morningstar.com about how retirees can use reverse mortgages well. Munnell is co-author of the forthcoming book Falling Short: The Coming Retirement Crisis and What to Do About It and an investor in Longbridge Financial, a company that offers reverse mortgages.

Morningstar: A key pillar of the retirement-savings approach you discuss in your new book is using home equity, including the idea of downsizing and pocketing the difference in home costs or of taking on a reverse mortgage. What should retirees and those nearing retirement think about when deciding between these two strategies?

Alicia Munnell: I think that the big message there is that you've been saving through your house all through your working years and it's an asset that you can use to help support yourself in retirement. There are two ways to go about tapping that home equity. If your house is too big, in a really good school district, and has many floors and a big garden, then it may not be the right house for you, and you really might want just a smaller house and a cheaper house. Maybe in the same neighborhood. Or if you want to go to someplace cheaper to live, then you should downsize. If you like your house and you want to stay there, then reverse mortgages are available as a way of tapping your home equity.

Morningstar: Some are critical of reverse mortgages due to the high upfront fees, but you have said they can be an effective retirement-savings tool. Why is that?

Munnell: I think that initially there was sort of mis-selling or tied selling [when a bank forces its customers for one service to also buy other services] with reverse mortgages, and they were sold also to people for whom they're not appropriate. They are not a last-ditch-effort product. You need to be sure that you have the resources to cover your property tax and your payments on your home insurance. So, therefore, you need to have some additional cash if you're going to take out this type of instrument. But for those for whom it's right or who can afford it, it will be a very valuable product over time because people are going to need to add their home equity to other sources of retirement income to get by.

Morningstar: What should those shopping for a reverse mortgage consider before making a decision?

Munnell: I guess you can look at the fees, but I think they're fairly standardized. I think that it's just familiarizing yourself with the product and being clear on what you're committing to do and making sure that it's the house that you want to stay in.

Morningstar: Let's talk a little about the mechanics of how a reverse mortgage works. Do I get to decide how much income I receive each month, and does this have an impact on how long that income stream lasts?

Munnell: You can take a reverse mortgage in a number of ways. They've eliminated taking it all up front, but you can take a lot in the first couple of years or you can take it as fixed payments over time, lifetime payments, or you can have it as a line of credit. So, I think, for most people, at least having it there as a line of credit [makes sense]. There are some fees; but if you don't use it, you're not going to need to pay back anything, and it's always there if you get in trouble. So, it seems like a valuable option.

Morningstar: What about timing? If you had taken out a reverse mortgage when the housing market crashed several years back, you'd be in much worse shape than if you'd waited a few years for the market to start to recover, right?

Munnell: If you took it out when your house was at a very low value, you would not get as much money out of it as you could [have].

Morningstar: Right. So, I guess my point is that you have to be careful in terms of when you initiate that reverse mortgage, correct?

Munnell: Right. It's a complicated instrument. I mean, when interest rates are low, you can get more than when interest rates are high because what happens is that the interest payments are added to the loan, which will then be paid off when the house is sold. So, if you are in a low-rate environment, you can get more than in a high-rate environment. If you're at the depth of the housing crisis, then you get less because the housing value itself is low. So, there are factors to consider here.

Morningstar: Should those using a reverse mortgage for retirement income view it the way they would an annuity, and what role does that income play in terms of asset allocation?

Munnell: So, it depends how you take it, right? So, if you take it in terms of a stream of income over the rest of your life, it is very much like an annuity in terms of how the payments seem to you. They continue for as long as you live, and then the money is paid back out of the sale of your house. So, it's a stable, predictable source of income that would allow you to take risks with the other part of your portfolio.