The Consumer Financial Protection Bureau (CFPB) gave a warning to consumers aged 62 and older who are considering a reverse mortgage to delay dipping into their Social Security benefits.
In a 26-page issue brief dated August 2017, the Bureau determined that: (i) the costs of using a reverse mortgage exceed the total amount of Social Security benefits one could receive in a lifetime by delaying it, and (ii) this in turn could diminish the equity in one’s home.
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Reverse Mortgage to Delay Retirement?
The Bureau found that approximately 5 million consumers will turn 62 by 2020. This is the minimum age to receive benefits under Social Security. But by doing so, one’s benefits will be reduced by the time he/she reaches the full benefit age of 67.
To prevent this scenario, some older homeowners delay their retirement. They do this by taking out a reverse mortgage whose proceeds can be used to meet their financial needs until such time as they achieve the full-benefit age.
This strategy, as the Bureau determined, carries financial risks for the older borrower. In taking out a reverse mortgage, the borrower pays for the following:
- Principal loan amount
- Interest
- Mortgage insurance premiums (MIP)
- Monthly servicing fees
- Origination costs
- Closing costs
And as some borrowers finance these origination and closing costs, they will be added to the outstanding loan amount, which will increase over time because of interest, MIP, and fees.
Age x Life Expectancy x Reverse Mortgage Costs
Let’s use the Bureau’s example: you have a monthly SS benefit of $910 when you reach 62. You delay claiming this benefit in lieu of a higher monthly benefit of $1,300. By the time you reach 85, your cumulative lifetime Social Security benefits will be $29,640 more than if you have claimed your benefits when you were 62.
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Supposing you will hold your reverse mortgage for seven years, which is the average period when reverse mortgages are held and paid off. Fast forward to seven years, you’re 69 and your costs of getting a reverse mortgage have totaled $31,900, which is $2,300 more than the Social Security benefits you’ll receive in your lifetime.
Not only that. When you reach 85, which is the expected life expectancy of a 62-year-old, your reverse mortgage costs would have totaled $178,000. Compare this to your cumulative Social Security benefits of $29,640 by the time you reach 85.
As the brief showed, the costs of getting a reverse mortgage outweigh the savings/gains you’ll receive when you delay claiming your Social Security benefits.
Diminished Home Equity = Limited Options for Homeowners
“Nearly 90 percent of older homeowners have net equity in their home. Compared to other financial resources, home equity is the most valuable asset for the largest number of older consumers,” the Bureau said.
The reverse mortgage costs however eat at the equity stored in one’s home. It will cost you $21,600 to take out a reverse mortgage when you are 67, equivalent to 40% of the principal loan you borrowed.
A diminished home equity can complicate your prospects to sell your home or move in the future. With limited options, you might have difficulty meeting a major financial need.
Recommendations
Home equity, together with Social Security, provides financial security to millions of older homeowners upon their retirement. What the Bureau recommends is for older homeowners to consider the pros and cons of using a reverse mortgage as a financial strategy.
As the Bureau’s Director Richard Cordray recognized, “A reverse mortgage loan can help some older homeowners meet financial needs, but can also jeopardize their retirement if not used carefully.”
“This is especially true for consumers whose primary source of income is Social Security and whose main asset is their home. For those consumers, the costs of a reverse mortgage loan will likely exceed the lifetime amount of money gained from an increased Social Security benefit, which in turn may threaten their financial security later in life,” the Bureau concluded in the report.
For more information, click this discussion guide from the Bureau.
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Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.
