Downsize or Take Out a Reverse Mortgage? Here’s What to Consider

On this episode of The Long View, Don Graves, president and founder of the Housing Wealth Institute and an instructor of retirement income at The American College of Financial Services, and Wade Pfau, professor of retirement income in the Financial and Retirement Planning Program at The American College of Financial Services and co-director of The American College Center for Retirement Income and Retirement Income Certified Professional program director at The American College, discuss retirement planning, housing wealth, and the benefits and drawbacks of reverse mortgages.

Here are a few excerpts from Graves and Pfau’s conversation with Morningstar’s Christine Benz and Amy Arnott.

Should You Downsize or Take Out a Reverse Mortgage?

Christine Benz: Older adults often find themselves in homes that are impractical to age in. They might be too large, or they have stairs, or they need costly repairs. Given that, is relocating to a more practical space often the better call than staying put and tapping home equity via a reverse mortgage?

Don Graves: It all depends on what the client wants to accomplish and where they live. For example, someone in California has a $400,000 home in San Francisco. It’s worth $1.5 million. And if they sell it, the capital gains are going to be pretty extensive. And so, one of the ways to say, well, you don’t have to sell it, you could do a reverse mortgage and stay to manage your capital gains. That’s probably the exception. But for a lot of folks, the home is not the right size anymore.

One of the things I ask—I train advisors for what I do—ask your client this: If we could increase your cash or reduce your expenses and add new dollars back to your retirement savings, but amid moving to your next, last, and best home, would you want to see how it works? Now that’s a financial planning question. So, you’ve got a client that sold their home and they’ve got $500,000 in proceeds left over. They could go to a $500,000 home and pay cash, or they could use the reverse for purchase program that came about in 2009 that would allow them to buy their next home today at about 60% down payment and have no monthly mortgage payments and then they’d have some excess money left over to add back to their savings.

So, a client says, “Well, Don, I’d like to do that.” So, here’s a $500,000 home, and the reverse mortgage would make $200,000 available, as an example. So, we subtract that. So, their down payment of $300,000 gets them into a $500,000 home. But remember, they had $500,000 in proceeds. So, they’re able to reduce their expense footprint and add $200,000 back to their retirement savings. You couldn’t do that with just the downsizing or moving. You’d have some money left over. But using the reverse repurchase amplifies that and increases it. And I think it’s an excellent consideration for many, many people.

Are HECM Mortgages Worth the Costs?

Amy Arnott: Another negative we sometimes hear about is the closing costs for an HECM [home equity conversion mortgage], which, as with any type of mortgage can be significant. And Don, in your book you cited an example: It could be about $16,000 total for a $400,000 home. But is that still the average number that you would see for that type of mortgage balance?

Don Graves: For the HECM, there are three costs—standard retail cost, 2% of the appraised value of the house goes to HUD for the initial mortgage insurance premium. So, on a $400,000 home, that would be $8,000. The second cost is what goes to the lender—2% of the first $200,000, 1% to a maximum of $6,000. So, for any home over $400,000, it’s $6,000. So that’s the second cost. And then the third one is going to vary by where you live. So, in my book, I defaulted to 0.5%, I think. But if you’re in Florida, that’s going to be more, and if you’re in Iowa, it’s going to be less. So, 2% goes to HUD, what goes to the lender, then your third-party charges. And I think Wade answered this question during covid. He had written an article, and I thought it was fantastic and someone pushed back and said, “Wow, isn’t that a lot?” That maybe the closing cost may have been $28,000.

And what Wade said—and I’ll have him chime in—but it was brilliant. He says that I believe that the benefit derived from any product, plan, or strategy should far outweigh the cost. And that’s when he did his paper about coordinating your withdrawal efforts and what could be left as a legacy benefit at the 30-year mark. And it’s something you said, Wade: Do I think reverse mortgages are expensive? Well, I suppose as long as they were less than $4 million because that was the legacy benefit versus zero, no, they weren’t expensive at all. And so, Wade, would you chime in on that when people talk about the retail cost of the reverse mortgage, how do you answer that?

Wade Pfau: Right. When you see that upfront all-in cost, it can give some sticker shock because, for a more highly valued home, it could be in excess of $20,000. And so that makes people nervous. But when I do all my research, I include the full retail costs as part of that. And then it’s ultimately, what does that cost mean with respect to what your assets were able to do in retirement? And that’s the scenario Don is talking about there. If strategic use of the reverse mortgage allows me to leave a $300,000 larger bequest at the end of retirement net of costs, well, was it really costly to do that? No, it’s like a savings of $300,000. So, that’s really how I try to frame fees or costs. It’s not so much just in isolation. Yes, that number looks big, but in the totality of retirement and what you’re able to do and how you’re able to build a more efficient retirement income plan, if you’re getting more out of those assets, the cost is really irrelevant to that. It’s what’s the net value at the end of retirement, and that can be a great net benefit that well exceeds these costs to set up the reverse mortgage.