Some people are “house rich” and “house poor” at the same time. They’re house rich because they own a house. They may own it outright or have a tiny mortgage balance. Either way, they’ve got a bunch of equity. But they can also be house poor.
How? Simple. Our homes can be costly beasts. Even if there is no mortgage, there are bills to pay. The real estate tax, insurance, utility, repair and other bills remain. Follow me in these examples and you’ll see how the use of a reverse mortgage can improve a cash-strapped retirement.
We’ll start with Dick and Jane Shortcash. Married for decades, they’ve educated their kids, avoided debt, and proudly own their $300,000 home, mortgage free. They live in a high cost area for shelter, so the operating costs on their home are about 4 percent of its value, or $12,000 a year.
That’s pretty good. But they’ve also had some hard times. They were forced to spend their limited retirement savings. While their specific figures vary, Dick and Jane are very much like the vast majority of Americans. They have Social Security and home equity, but little else.
So at 66 they suddenly find themselves involuntarily retired and applying for Social Security benefits. Consistent, medium income workers, their combined benefits total $37,000 a year. After paying their shelter bills, they have $25,000 to live on.
Can they do it? Sure. Millions of lower income retirees get by on far less.
Will they be comfortable? That’s doubtful.
Here are three ways Dick and Jane can increase their spendable income using a reverse mortgage. Two of the three ways also create retirement funds that will help them survive the financial shocks that often come with old age.
(1) They can get a reverse mortgage on their home and have a line of credit or a guaranteed lifetime monthly payment. Using Professor Wade D. Pfau’s online reverse mortgage calculator I found that the Shortcashes were eligible for a net credit line of $164,700 or a monthly payment for life of $938 a month, $11,256 a year. The credit line automatically increases each year.
So cash advances will cover the annual cost of shelter and their spendable income increases from $25,000 to about $36,256. That’s an increase of nearly 50 percent. All tax free and without moving.
(2) They can make a sideways shelter move to a lower cost area where the annual cost of operating a house is about 3 percent of market value. In that move they can buy a new house for about $300,000 with a purchase money reverse mortgage, putting down less than 50 percent. With the purchase money reverse mortgage they will have no mortgage payment and will be able to stay in the house until they die or are no longer capable of living there. The lower operating expenses, $9,000, will also be nice.
Finally, since they only had to put about half down, they have about $150,000 left to create a retirement fund. If they draw from the fund at five percent, they’ll have $7,500 a year to add to their Social Security benefits. Net result? Their after-shelter spending can be $35,500. Other benefits may come from moving to a lower cost area such as a lower (or no) state income tax, lower insurance costs and lower food, medical and other costs. Actual figures will vary, but this result is close to staying put with a reverse mortgage. The big difference: they now have the added security of an actual retirement fund.
(3) They can transform their retirement with a downsizing move to a lower cost area. In this move they opt for buying a $200,000 house using a purchase money reverse mortgage. This gives them a smaller, more easily managed house with annual operating expenses of only $6,000 and no mortgage payment. Since they only had to put $100,000 down using a purchase money reverse mortgage, they can use the remaining $200,000 as their retirement fund, drawing $10,000 a year. Net result? Their after-shelter spending can be $41,000. That’s an increase of 64 percent in their after-shelter spending from staying at home and doing nothing.
Are these exact figures? Not at all. Transaction and moving costs have not been considered. But it’s worth emphasizing that this is after-shelter spending. Shelter accounts for nearly 40 percent of spending by retired people.
How it works out in detail will depend entirely on personal decisions about shelter. That’s a good thing.