Over the last few years, I’ve spent a great deal of time talking to people in or approaching retirement, and I’m here to tell you that when it comes to looking at retirement, we are in general an overly optimistic bunch. I’m not saying we should be pessimistic about our futures… I’m just suggesting a little honest reality check is in order.
For example, I’ve found that many retirees overestimate their ability to pay off mortgages and/or access the equity in their homes.
Problem #1: Accessing home equity is nothing like it used to be.
It was only a few years ago that if you had equity in your home and you wanted to convert some of it into cash, you could easily get approved for a Home Equity Line of Credit (HELOC) or second mortgage… but those days are long gone. Getting approved for a HELOC today is nothing like you remember it.
Today, there are “ability to repay” rules that impose strict income requirements on approval for these and virtually all other home loans. That means that even if you have a high FICO score… and plenty of equity in your home, that may not be enough to get you approved. Today, in order to qualify, you’ll also need to show that your income is sufficient to repay the loan along with all of your other expenses.
The amount of equity you have doesn’t matter when we’re talking about qualifying under the new “ability to repay” rules.
Today, it’s about your monthly income and if you’ve stopped working, monthly income is probably the one thing you’re lacking. And, if you remember how you used to be able to get a HELOC and then use the cash you got from the loan to make the monthly payments? Well, you won’t get a loan on that basis anymore either.
Not that taking out a HELOC is a great idea during your retirement years anyway. It’s really a terrible type of loan for older homeowners because although it allows for interest only payments for ten years, after that the loan becomes fully amortizing, meaning the monthly payments can increase quite a bit after that first decade of interest only payments has ended.
If you took out such a loan such when you were 65 and still working, you’d be 75 when the payments jumped up, and if by then you’ve stopped working and you’re income has gone down as a result, those higher payments can cause real problems… and without your working income, you may not be able to refinance to pay off the HELOC.
Today we’re witnessing the impact of HELOC payments increasing ten years after their origination, and more and more homeowners are finding their way into foreclosure as they are unable to make the higher monthly payments… nor are they able to refinance under the new rules.
Problem #2: You can’t safely retire with a mortgage.
Traditional mortgages were never designed for people in their retirement years. The idea has always been by the time you turned 65, you had already paid off your mortgage.
However, the refinance boom that ended in 2008, left millions of older homeowners with mortgages, which is a state of affairs that never existed in past years. A recent report from Harvard University’s Joint Center for Housing Studies showed that as of 2010, “40 percent of households 65 and up were still paying a mortgage.” Contrast that with data from 1992, when only 18 percent of homeowners over age 65 were still making monthly mortgage payments.
Without a monthly mortgage payment, the idea was always that you could get by on Social Security, a pension and whatever savings you had accumulated during your working years.
The problem today is that 10-12 million older homeowners still have mortgages, with many having refinanced only a few years ago… while at the same time far fewer retirees have pensions on which to rely… and most people haven’t been able to save nearly enough to support their lifestyles through what may turn out to be decades of retirement.
Consider that during the 1930s, when Social Security was established, people started receiving benefits at age 65, and the life expectancy of the average male was about 67. Today, the average 65 year-old male’s life expectancy is roughly 80… and the average 65 year-old female lives a bit longer than that. The average 80 year-old male today can expect to live until he’s close to 90, and the average 90 year-old can expect to make it until almost 95.
Never before have we faced the prospect of having to support ourselves for 20-30 years of retirement without running out of money before we reach our life expectancies. And although at 59, I wouldn’t claim to know everything about retirement, one thing I’m sure of is that running out of money at 80… and living until you’re 90 or beyond… would be bad.
Last week, salon.com published an article titled: 401(k)s are a sham. It’s about the many inadequacies of 401(k) plans, when trying to accumulate enough wealth to maintain one’s lifestyle once retired. The article concluded that…
“The United States is on the verge of a retirement crisis. For the first time in living memory, it seems likely that living standards for those over the age of 65 will begin to decline as compared to those who came before them…”
Do the math and you’ll quickly come to realize that as long as you’re still making a mortgage payment, you can’t really retire. I mean, it’s hard enough to make it for 10, 20 or 30 years without a paycheck from work even if you don’t have a mortgage payment to make each month… but with a mortgage payment, for most people, it’s pretty much impossible.
I’ll just work until I drop dead?
I can’t even count the number of people who have told me that their plan for retirement is to keep working until they drop dead. The problem is that although it’s a cute phrase and maybe a comforting thought… too often, life simply doesn’t work that way.
I recently wrote an article about this fact of life, titled: You Can’t Count on Working Past 65, and it showed that based on a recent study conducted by the Employee Benefit Research Institute and others, “50 percent of Americans who plan on working past 65 find themselves retiring unexpectedly.”
The reasons given for retirement coming earlier than planned included health problems in 60 percent of cases… 22 percent said they had to stop working to care for a family member… 27 percent attributed their unexpected retirement to changes at their companies… and 10 percent said that new skills required on the job was the cause of their having to stop working sooner than they’d planned.
Obviously, if you’re forced to stop working sooner than you expected and while you’re still obligated to make a monthly mortgage payment, the combined impact on your financial situation can fall somewhere between problematic and catastrophic.
In the best case scenario, you’ll be forced to start spending down your nest egg to make the mortgage payments each month, but that can mean running out of money well before reaching your life expectancy. Or, you could be forced to sell your home, when that’s the last thing you wanted to do.
Enter the HECM reverse mortgage…
The only practical way to access home equity once retired is by using a Home Equity Conversion Mortgage, or HECM for short, which is the reverse mortgage that’s regulated by the U.S. Department of Housing and Urban Development (HUD)… and is insured by the FHA.
The problem is that I’ve found the HECM reverse mortgage to be poorly understood by almost everyone.
So, let’s start by understanding that a HECM reverse mortgage is just an FHA mortgage that offers the option of not making payments until the borrower(s) die… or the home is sold.
With a HECM you can make interest only payments… or you can make payments of principal and interest… or you can make no payments at all. You could decide to make no payments for five years and then make a payment of $50,000, for example, it’s entirely up to you.
Having a HECM reverse mortgage is just like having any other mortgage. You own your home… you pay your property taxes, insurance and normal maintenance… and you leave the home to your heirs just as you would with any other type of mortgage.
How to Qualify for the HECM…
To qualify for a HECM you must be 62 years of age or older and have enough equity in your home to make the numbers work, but in addition, there are relatively new “financial assessment” rules that apply to qualifying. Those rules make it harder to qualify than it was prior to the new rules taking effect (but it’s still easier than qualifying for a traditional mortgage).
The new rules require that homeowners pass a new “financial assessment” test in order to determine whether they have sufficient income to pay their debts and living expenses, along with their property taxes, insurance and normal maintenance. It sounds reasonable enough on the surface, but for a number of reasons the new rules can make it significantly harder to qualify for the HECM reverse mortgage.
The new rules mean that if you wait until you really need a reverse mortgage, you may not be able to get one.
I’m not trying to be an alarmist or say that everyone should rush out and get HECM reverse mortgages, but what I am saying is that everyone should come to understand how the HECM works and how it could apply to their individual circumstances. If it proves to be something that would help in some significant way, then knowing now is better than finding out later when you may not qualify for any number of reasons.
Here are examples of what can cause you not to qualify…
1. New Income Requirements – The new financial assessment rules mean that you have to have enough monthly income to pay all of your bills, your property taxes, insurance and normal maintenance… and still have enough left over for normal living expenses. So, if your income were to drop unexpectedly, it might mean that you no longer qualify for the HECM reverse mortgage.
And the fact is, your income can drop at anytime for any number of reasons during retirement. I’ve seen husbands die unexpectedly and leave their wives trying to get by on half the income they had before his death. I’ve seen people have heart attacks or strokes out of nowhere and have to stop working way before they planned to stop. I’ve seen couples divorce, which always costs more than anyone thought, and I’ve seen people laid off from jobs they never thought they’d lose.
2. Home Values & Interest Rates Go Up and Down – One thing we should have all learned from the meltdown that hit our economy in 2008, is that home values can go up… and they can go down. Well, I’ve seen several cases where based on a home’s appraised value today the homeowner qualified for the HECM, but if that value were to drop by even 10 percent, or interest rates were to rise by a single point, they would no longer be able to take advantage of the HECM.
This factor alone should be a wake up call for homeowners over 62 everywhere. Right now interest rates are still quite low. Low rates mean that homeowners have more borrowing power than they will when rates rise. In addition, although we’ve seen home prices rise over the last couple of years, many economists are predicting home prices to pull back over the next 2-3 years.
I can’t help but worry about the homeowners over 62 today who haven’t taken the time to understand why they might switch their existing mortgage over to a HECM, and who will find themselves unable to take advantage of the HECM in coming years because of reduced income, higher interest rates, lower home values, or some combination of the three.
3. Realities of Retirement – The reality of retirement is that at some point, it’s likely that your income will drop. According to a recent Employee Benefit Research Institute study: “50 percent of Americans who plan on working longer find themselves retiring unexpectedly.” The reasons for such unplanned retirements from work include health problems, changes at work, and having to care for a family member.
4. Unplanned Medical Expenses – As someone once said, no one gets notified in advance that: “Your heart attack will be next Tuesday at noon.” And that’s the way it is with medical bills and health care costs in general… they show up without warning. One study I read recently showed that people spend just under $400,000 on medical care during the last five years of their lives.
Large unexpected bills that dramatically harm your financial stability can cause you to fail the HECM financial assessment and make it impossible for you to qualify. However, let’s say you had opened a $300,000 HECM Line of Credit at age 62. That line of credit is guaranteed to increase every year by whatever the interest rate is each year, regardless of the home’s market value.
So, if the interest rate were to stay at 4 percent, that $300,000 line of credit in 20 years would be worth roughly $800,000… when you’re 82. That’s a very nice tax-free financial cushion to have should you need to pay for in-home care in order to remain in your home… or to pay for assisted living or skilled nursing care for that matter.
I have to tell you that to my way of thinking, waiting to set up a HECM Line of Credit makes no sense whatsoever. If you never need to access the funds that’s just great, but if you do find yourself facing exorbitant medical expenses later in life, you’ll be thrilled that you have a source for the tax-free cash you need that doesn’t have to be repaid until after your death from the sale or refinance of your home.
5. Credit Card Debt – Let’s say that you’re forced to use your credit cards to pay some unexpected expenses and then you want to use the HECM to pay them off. Well, that may not work because today you can’t use a mortgage to pay off debts unless they are recorded liens on your property. So, to qualify for the HECM, you’d have to have enough income to support the minimum payments on your credit cards, even though your plan is to use the proceeds from the HECM to pay off those debts.
6. Late Payments – If you find yourself struggling to make ends meet during retirement, whether because your income drops or your expenses rise, it could cause you to fall behind on one thing or another. If that happens, it could prevent you from being able to utilize the HECM.
The HECM reverse mortgage is not a credit driven product, which means there’s no minimum credit score needed to qualify. However, if you’ve missed a few payments over the last two years, whether for property taxes or credit cards, you could find out that as a result, you can’t use the HECM after all. It’s not an absolute rule or anything like that, but it definitely can happen.
Here are the top examples of what most people don’t realize about retirement…
A. Retirement today is measured in decades, not years. Imagine trying to live your life for 20-30 years without getting a paycheck from work? I don’t know about you, but it sounds impossible to me.
Think about how long 20-30 years really is. How can you hope to predict what will happen to you over that many years? Imagine it’s 1980 and you’re trying to predict what will happen to you by 2010… without a paycheck from work the entire time, and trying to survive on a government check of $1500 a month. Think about that. It’s horrifying.
It’s life’s cruel joke that although we’re living better than past generations… and we’re living longer than ever before… that also means that if we’re not extremely careful, our last ten years are increasingly likely to be spent living closer to the poverty line than we ever did during our working years.
B. We overestimate the value of our savings and underestimate how much we’ll need to maintain our lifestyles once we’ve stopped getting a paycheck from work. We assume that we’ll need less money each month to live on when we’re older, but studies show this isn’t a well-founded assumption.
Think about it and you’ll realize that most of our living expenses don’t change just because we stop working, and some like health care costs are all but certain to increase significantly.
Now, let’s say you’re 65 and have $500,000 in your 401(k) or IRA. That sounds like a fair amount, until you stop to realize a few things. For one, it might have to last 30 years. For another, withdrawals are taxable as ordinary income, so if taxes go up in the future, and I can’t find anyone who doesn’t think they will, then your accumulated savings will provide less than you thought.
And, we should all know by now that stock markets go up and stock markets go down (and I never seem to get in before they go up… nor do I ever get out before they go down.) If you have $500,000 in your 401(k), and the market drops by 20 percent, as it has quite recently, as a matter of fact… then your $500,000 just turned into $400,000.
Now, if you don’t need to use that money, maybe you can avoid taking withdrawals until the market comes back, assuming it does… but if you need to use that pool of money for living expenses, then once the market drops, you’re simply stuck living on less than you’d planned.
I know that for many people, 65 is still young enough to keep working, but 75 may be another story altogether… and few among us are able to continue working into our 80s.
Remember, when you have a HECM reverse mortgage you can keep making payments, if that’s what you want to do, but should something cause you to stop working unexpectedly, at least you won’t have to worry about being forced to sell your home… or in the worst case scenario, losing it to foreclosure.
If you’ve already paid off your mortgage, consider opening a HECM Line of Credit now… before you need it… meaning while you can still qualify for it. A HECM Line of Credit cannot be cancelled so it’s guaranteed to be there for the rest of your life… and it goes up each year by whatever the interest rate is for that year, plus half a point. So, if the interest rate is 3.5%, then your HECM Line of Credit would increase by 4% a year.
Lastly, think about downsizing into a less expensive home, which is often a good idea, by the way. You may not be able to increase your income in your 70s, but if you can reduce your monthly expenses, it’s sort of the same thing.
So, go ahead and sell your home, but don’t pay cash for the next one. Instead use a HECM for Purchase to buy your retirement home and that way you’ll be able to hold onto more of your cash and won’t have to make monthly payments on the mortgage unless you want to.
For example, using a HECM for Purchase, I was able to help a woman in her 70s, buy a $600,000 home with only $260,000 down, instead of paying cash. That meant that she kept $340,000 in her bank account that would have been buried in her new home had she paid cash for the property… she never has to make a mortgage payment… and assuming she pays her property taxes and insurance, she can live in that home without paying a single mortgage payment for the rest of her life.
Is the HECM for Purchase a better way to finance a home during retirement than any other… there’s no question in my mind that the only answer is a resounding YES. In fact, it’s not only better… it’s MUCH, MUCH better.
So, times have changed, and our views need to change too.
Change #1: Today, the money you put into your home by making mortgage payments is essentially buried in your back yard because, in many cases, once you’ve retired, the only way to get that money out will be to sell the home.
Change #2: Today, retirement is measured in decades, not years. At 65, you could be looking at having to maintain your lifestyle for 20-30 years, much of that time without getting a paycheck from work. That’s not going to be easy for anyone… for many it will prove impossible.
It’s a fact: The HECM reverse mortgage, depending on how its used, could be the difference between living comfortably throughout one’s retirement years… and scraping by, stressing out, and trying to survive for the last decade or longer of your life.
I’ve devoted much of the last decade writing about the financial and foreclosure crisis because I wanted to help people understand what was happening and because I wanted to help people avoid losing their homes to foreclosure.
Now I’m on a mission to make sure everyone I talk to comes to understand how the HECM reverse mortgage, if intelligently applied to their individual circumstances, can be the most effective tool in today’s retirement toolbox. I’m not saying you shouldn’t save more or diversify your portfolio… by all means do whatever you can to improve your position related to retiring.
But whatever you do, don’t let uninformed negative soundbites keep you from learning about how the HECM reverse mortgage, the HECM for Purchase, or the HECM Line of Credit can help you achieve your retirement objectives, and definitely don’t wait until disaster strikes, because the new rules could put the HECM out of reach when you need it most.
Mandelman out.
