Using a reverse mortgage to delay Social Security can be costly
Delaying Social Security benefits by just five years can increase a retiree’s monthly benefits by as much as 30 percent for the rest of their life. But how to come up with the money to replace Social Security benefits for five years? For some homeowners, a reverse mortgage is their best answer.
Using money from a reverse mortgage can fill some of gap of not having Social Security benefits, but it can also jeopardize the borrower's retirement if not used carefully or if the loan costs more than what they’ll gain.
In general, the reverse mortgage loan costs exceed the additional amount of money in lifetime Social Security benefits a homeowner receives by claiming higher Social Security benefits at age 67 instead of at 62, according to a report by the Consumer Financial Protection Bureau.
The average reverse mortgage is for seven years. If a homeowner gets one at age 62 and then pays it off seven years later at age 69, the reverse mortgage loan costs $2,300 more than the lifetime amount gained from an increased Social Security benefit if the homeowner lives to age 85, the CFPB found. A reverse mortgage loan can be paid off at any time and payoff doesn’t have to wait until the house is vacated. If they kept the reverse mortgage until they died at age 85, the reverse mortgage would cost them $29,640 more.
Why delay Social Security?
Social Security benefits are the main source of income for most retirees. About 85 percent of Americans 65 and older receive income from the government agency, according to the Social Security Administration, accounting for 63 percent of their income. For beneficiaries 80 and older, Social Security accounts for 71 percent of their income.
Benefits can be claimed as early as age 62, but they’ll be set at a permanently reduced amount. An easy way to receive more money is to wait until age 66 or 67, depending on their year of birth, to be eligible for full benefits that can be up to 30 percent higher than at age 62, according to the SSA. Inflation-adjusted payments are set for a beneficiary’s life.
For those who live beyond the average life expectancy of a 62-year-old today (about age 85), they’ll get more money from Social Security cumulatively by getting a higher benefit by waiting until age 67 than someone who chose to receive lower payments for a longer period starting at age 62.
It’s even higher at age 70. For someone whose full retirement age is 66, they’d get 108 percent of their monthly benefit by delaying the start of retirement benefits until age 67, and they’d get 132 percent of the monthly benefit by waiting until age 70, according to the SSA.
The SSA offers the example of a woman age 62 today who lives to age 85. She will receive $29,640 more in cumulative benefits during her lifetime if she claims a monthly benefit of $1,300 at age 67 than if she claims a monthly benefit $910 at age 62.
Home equity can fill the gap
Pensions, retirement plans, stocks, savings and working longer can help fund retirement from age 62 to 67 while waiting for a higher Social Security payment to start.
But home equity is the largest asset of households 65 and older, according to a CFPB analysis of the Federal Reserve Board.
One way to tap that equity in retirement is through a reverse mortgage, which is a loan only provided to homeowners 62 and older. Substantial home equity is required, and borrowers can still live in their homes.
Loan funds can be received as a lump sum, monthly payment, line of credit or a combination of the three.
The loan and interest is repaid when the borrower moves or dies. Often the home is then sold by the lender, and any money above the loan goes to the borrower or their heirs. The average borrower holds a reverse mortgage for seven years, according to a study of reverse mortgage loans issued before 2006.
Federal rule changes on reverse mortgages in 2013 made it a little more difficult to qualify, partly to protect seniors. These included reducing the maximum loan amount to 57.5 percent of the house value that could be borrowed, lower closing costs, higher upfront fees, reducing initial withdrawals, and checking the ability to pay property taxes and insurance.
Reverse mortgage risks
A reverse mortgage loan can be an expensive way to delay collecting Social Security benefits. Just having a $54,600 reverse mortgage from age 62 until full retirement age at 67 will cost $21,600 in loan costs, the CFPB says. These include origination costs, interest, mortgage insurance premium and fees, and add up to about 40 percent of the principal borrowed.
Only two years later, the loan costs are $31,900, or about 60 percent of the principal borrowed.
However, many older homeowners, especially those whose home is their main asset, are unlikely to have the resources to repay the reverse mortgage loan immediately upon claiming full Social Security benefits unless they sell the home, according to “Aging in Place,” an analysis of reverse mortgages. A reverse mortgage calculator can help figure out how much the loan will cost.
Taking out a reverse mortgage at age 62 can also reduce equity in a home, which can be a problem later if the homeowner wants to sell their home and move. Their reverse mortgage loan balance will likely grow at a faster rate than their home will appreciate, according to the CFPB.
Their heirs will also receive less equity. That argument against a reverse mortgage shouldn’t hold much weight, says T. Eric Reich, president of Reich Asset Management in Marmora, N.J.
“Your kids do not want your house,” Reich says. “Even if they do, they likely can’t afford it. Or, how do multiple kids split a house?”
Arguments in favor or a reverse mortgage
If used to pay for living expenses and protect cash and investments, a reverse mortgage can be a smart move that still leaves an inheritance, Reich says.
Scott G. Eichler, vice president of institutional wealth management at Newport Wealth Advisors in Newport Beach, CA, says he typically recommends using a reverse mortgage or spending down their retirement assets in their 60s to delay Social Security.
Their heirs won’t inherit as much when they sell the home, or they won’t be able to live in it if they can’t repay the loan, Eichler says, but that should be secondary to the borrowers’ needs in old age.
“As much as I’d like to see parents hand something down to their kids, I’m more concerned with making sure the parents don’t run out of money during retirement,” he says.
“That being said, that typically is not the case. By using a reverse mortgage, we are able to keep more money invested in the market. That money will typically grow at a faster pace than if it had stayed in the house and earned no return.”