Why Paying Off a Mortgage is the Most Common Reason To Get A Reverse Mortgage
Based on a Consumer Finance Survey from 2013, the National Council on Aging reports that 33.8% of seniors owed money on a mortgage, line of credit or both.
According to the CFPB, 21.2% of home owners aged 75 and older owe money on a mortgage.More than half of retired homeowners spend 30% of their household income on housing-related costs. When housing costs exceed 30% of household income it puts the homeowner at greater risk for financial harm.
How Much Cash Flow Would You Keep With No Monthly Mortgage Payment
The question you need to ask yourself is, how much of your cash flow would a reverse mortgage save you monthly and over the next 15 to 20 years? More than likely you refinanced in the early to mid-2000’s when interest rates were at their historical lows. More than likely you opted for a 30-year fixed loan to keep your payments as low as possible. If that describes your current mortgage situation, then you probably have 15 to 20 years left before that loan is paid off.
How much would you save on a monthly, annual and remaining term of your current mortgage? Grab your current mortgage statement and look for the principal and interest portion of the payment. The principal and interest will tell you how much you would save per month. Then multiply the principal and interest payment times 12. This will give you your annual savings. Then multiply the principal and interest payment over the remaining months left on the term for your overall savings.
Do keep in mind that you will be required to continue to pay property taxes, homeowners insurance, as well as any other property charges and continue to maintain your home.
Let’s assume your mortgage payment is $989 which does not include taxes and insurance, and that you have 216 payments left, or 18 years before the loan is paid off.
Monthly Savings: $989 Annual Savings: $11,868 (12 x $989) Term Savings: $213,624 (216 x $989)
No matter which way you look at it, you end up retaining a lot of cash flow on a monthly or annual basis, and a staggering amount of cash flow over the remaining term of the loan. This is money that you are free to do with you as you please. You can pay for other expenses such as medication, go out to dinner with friends more often or save it for a rainy day.
As exciting as those monthly, annual or term payments savings can be,they can get even better. Hard to believe, I know. If you opt for the life expectancy set aside, they can be. Remember, the life time expectancy set aside, or LESA, is an escrow account that is set up to pay your taxes and insurance for you. The LESA is either optional or required depending on whether you pass the Financial Assessment.
Let’s assume you pass the Financial Assessment, but you decide you want to use all or some of the equity available, beyond paying off your current mortgage balance, so you no longer need to pay taxes and insurance.
Using the example above, let’s also assume your property taxes are $2500a year and your insurance is $600 a year. That is an additional $258 a month you are spending, assuming your taxes and insurance are escrowed with your mortgage payment. This means your principal, interest, tax and insurance payment is$1247 a month. If you opted for or were required to set up the LESA, your savings would be as follows.
Monthly Savings: $1247 Annual Savings: $14,964 (12 x $1247) Term Savings: $269,352 (216 x $1247)
Using the LESA you would be freeing up a tremendous amount of cash flow. This cash flow can then be used for a variety of purposes, including savings. This also puts less strain on your cash reserves and retirement accounts. The less funds you need to draw from your retirement accounts, the longer they can last. The longer you can make them last means less stress and anxiety you’ll have about money during your retirement.
What if You Need Cash to Close the Reverse Mortgage?
There are circumstances where you may need to come up with cash to close the loan. This may be due to a lower than expected value from the appraisal, not enough equity or being required to set up the LESA. The question then becomes, does it make sense to use funds from your retirement accounts to do so?
At this point you need to answer several questions:
- Do you have the funds available to close the loan?
- Do you want to use these funds to get rid of your monthly mortgage payment?
- How long would it take to break even?
- Does it make sense?
You will also need to consider that there may be tax ramifications to pulling money out of these accounts. This means you will need to pull more cash from these accounts to net what you need to close the loan or to have extra cash to pay the taxes on your own at the end of the year.
The obvious and immediate benefit to coming in with cash is that you will be getting rid of the monthly mortgage payment. The downside is using liquid assets to accomplish this.
If the thought of using retirement funds or savings to close the loan makes you uneasy, here is something to think about. Once the reverse mortgage is closed, you can replace the funds. This could be accomplished byre-investing the monthly mortgage payment back into the retirement or savings account it was removed from. However, you may be unable to replace funds used from specific types of retirement accounts. Consult with your financial advisor.
If you had to use $15,000 from savings to close the loan and, assuming your monthly mortgage payment was $1247, it would only take 12 months to replenish the funds that were used. Your breakeven point is 12 months. If you had 10 years left on your mortgage, you are reducing the pay off by 9 years.
The other thing to consider is you that you now have some flexibility in your budget. If you have unexpected expenses arise, you do not have to make a full payment towards replenishing your savings or retirement accounts.
Examples of Breakeven Points Assuming a $989 Monthly Mortgage Payment*
*For illustrative purposes only. $989 monthly mortgage payment is assuming principal and interest only and does not include taxes and insurance. Structuring the Loan
There are several different loan options with the reverse mortgage.These options were covered earlier, but we will cover them briefly again. You can have the option of a fixed rate or an adjustable rate.
With the fixed rate, you get a lump sum that will pay off your current loan, plus potentially give you cash in hand. With an adjustable rate mortgage,you have other options such as a line of credit, receiving monthly payments for as long as you live in the home or for a specified term. You can also opt for payments plus a line of credit with the adjustable rate.
If there is very little, or no equity available to you after paying off your current loan plus the closing costs, then the fixed rate reverse mortgage is probably the best option.
If, after paying off your current loan and the closing costs, there is a sizable chunk of equity available to you, then you may want to consider using the adjustable rate mortgage. This would give you access to more equity in the form of a line of credit, receipt of monthly payments or both.