With inflation at a 40-year high, many Americans are struggling to make ends meet. Inflation can be particularly problematic for retirees, forcing some to tap their long-term investments much earlier than expected to cover the rising costs of living.
In addition to rising costs, inflation has sparked unpredictable investment markets, record-high stock market volatility and rate increases by Federal Reserve this year. What’s more, most older Americans are not financially prepared for the rise in healthcare costs and the impact of inflation on Medicare benefits. The standard Medicare Part B premium will be 14.5% higher in 2022, meaning retirees will spend more money than ever on healthcare, leaving them with less to fund other aspects of their retirement.
Most of today’s retirees are facing financial challenges they didn’t account for when envisioning their golden years. For many, the financial plan they thought would carry them through will need to be adapted to cover rising costs. Those who are unable to increase their cash flow by returning to work or tapping another revenue stream are left with the option of selling investments at a loss.
For the retirees who planned to fund their retirement lifestyle with interest income, what does the future hold? As clients raise this concern, it will be crucial to know how to articulate the strategies for using home equity to fill the financial gaps caused by inflation and a volatile market.
Mitigating sequence of returns risk
There is one bright spot amid the doom and gloom many clients feel when viewing their current retirement portfolio: their record-level home equity.
Home values have grown to historically high levels, and Americans aged 65 and older have an almost 80% homeownership rate. One possible saving grace for retirees is the ability to realize real dollars from their home equity. Tapping into their record levels of home equity can be instrumental in protecting retirees from the impacts of inflation by mitigating sequence of returns risk. Home equity can provide the immediate cash conversion they need to cover unforeseen expenses and the increasing cost of living, while potentially leaving their investments intact.
If a client is considering mitigating sequence of returns risk by tapping their home equity, here are some important questions to ask:
· Would tapping home equity be less costly than selling investments at a loss?
· Are you losing money by not taking advantage of compound appreciation?
· Are you carrying a traditional mortgage, and if so, would you benefit from eliminating your mandatory mortgage payments and automatically increasing your cash flow?
Home equity options for older homeowners
It is essential to help clients fully understand the benefits and risks of home-equity loan products for older homeowners.
On the benefits side, tapping into home equity can be a great way to access cash quickly, improve a financial portfolio or cover significant expenses like home improvements, debt consolidation, college tuition or other emergency expenses.
A home equity conversion mortgage (HECM) has the benefits of a traditional line of credit and provides some benefits that conventional lines of credit cannot, including a flexible repayment feature. A HECM allows a borrower to convert some of the equity in their home into income-tax-free funds. [Note: This is not tax advice and consulting a tax professional is recommended.] Unlike a traditional mortgage, home-equity loan or home equity line of credit, no monthly principal and interest payments are required if at least one of the borrowers lives in the home as their primary residence. [Note: As with any mortgage, you must meet your loan obligations, keep current with property taxes, insurance, and maintenance.]
In addition to HECMs, many lenders also offer proprietary reverse mortgage loans. These types of loans can give a borrower more proceeds, or provide the borrower with lower costs, depending on their situation. In the current rate environment, many borrowers are choosing a proprietary reverse mortgage product, as it can give them a higher loan amount with less closing costs than they would be required to pay with a HECM loan.
Another advantage for reverse mortgage borrowers is that they can take their funds as a lump sum, a line of credit, a steady stream of monthly advances for a set time, monthly advances for as long as they live in the home or a combination of these options. [Note that borrowers who elect a fixed-rate loan will receive a single disbursement lump sum payment. Other payment options are typically available only for adjustable rate mortgages.] While there will still be a lien on the house for the outstanding amount of the loan, borrowers are not required to make monthly principal and interest payments on the reverse mortgage, and this can have a huge positive impact on a retiree’s monthly cash flow.
There are some cautions to consider. As with any mortgage, you must meet your loan obligations, keep current with property taxes, insurance, and maintenance. Borrowers should know their loan balance increases over time as interest on the loan and fees accumulate.
Borrowers should also understand that as they use their home equity, their heirs must repay the loan balance to keep the home when they inherit it. Frequently, heirs will elect to sell the house to pay off the loan balance, and those who elect to keep the home will often refinance through a traditional mortgage.
For most older Americans, speaking with their financial adviser is a cathartic session; they want to come away from the meeting feeling confident and hopeful. Unfortunately, today’s economic climate may not provide that opportunity for every client. Being well-versed in all the options for navigating retirement in volatile market conditions is key. And although using home equity to mitigate sequence risk and cover the rising cost of living may not be the right strategy for every client, it’s a strategy worth discussing.
Christian Mills is head of financial adviser relations at Reverse Mortgage Funding LLC.