As the number of aging baby boomers approaching or entering retirement continues to grow, accountants and tax professionals may be asked for advice on the best ways to maximize clients’ income. One tactic not to consider: using a reverse mortgage to delay collecting Social Security.
That’s the latest warning from the Consumer Financial Protection Bureau (CFPB) in its new study, “The Costs and Risks of Using a Reverse Mortgage to Delay Collecting Social Security.”
“The CFPB examined different scenarios and found that, in general, the reverse mortgage loan costs exceed the cumulative increase in Social Security that homeowners would receive in their lifetime by delaying Social Security benefits,” the bureau states in its study. “Furthermore, using this strategy will likely diminish the amount of home equity available to borrowers later in life.”
That reduced equity could prompt homeowners to try to sell their homes, but they will face fewer choices for moving to a new location or handling a financial shock, according to the CFPB.
A reverse mortgage loan is available to homeowners who are at least 62 years old. Borrowers don’t repay the loan until the last borrower dies or moves from the home as long as they live in the home, take care of it and pay their real estate taxes and homeowner’s insurance.
The CFPB forecasts that five million homeowners will turn 62 by 2020 and is also concerned that a broad promotion of this type of service could lead to more homeowners pursuing borrowing a reverse mortgage. Social security and home equity are likely to be the main sources of income for retirees amid limited savings plans for retirement and income from pensions.
As some retirees calculate, they could use the reverse mortgage loan proceeds as income to replace what they otherwise would get in Social Security benefits between their minimum claiming age of 62 to their full retirement age of 66 or 67 (depending on when they were born) or their maximum-benefits age of 70.
But home equity also is a key financial tool for retirees. According to the CFPB, 80 percent of retirees 65 and older owned their homes – and the majority owned them outright without any mortgage – in 2015. That makes home equity the most valuable asset for most of older consumers. In 2013, for example, home equity comprised almost 20 percent of all assets held by older consumers — far more than IRAs, cars, 401(k)s and so on.
But reverse mortgages tap into that home equity and reduce it. Not only do homeowners take on the principal loan amount, but they also pay for interest, mortgage insurance premiums and monthly servicing fees — all of which are added to the loan amount monthly. Origination and closing costs also are often added to the loan balance.
“We find that, in general, the reverse mortgage loan costs (i.e. origination costs, interest, mortgage insurance premium and fees) will exceed the additional amount of money in lifetime Social Security benefits a homeowner will realize by using this strategy,” the CFPB states.
Here’s an example. The average homeowner holds a reverse mortgage for seven years. If the homeowner is 69 at the end of that period, the reverse mortgage costs would total $31,900 — about $2,300 more than the lifetime amount of money ($29,640) gained from Social Security benefits if the homeowners lives to 85.
And by 85, the reverse mortgage loan costs would be $178,000, about $149,000 more than that lifetime amount of money from Social Security if the homeowner lives to 85.
However, there is a caveat. If the reverse mortgage loan is repaid when the homeowner is 67, the loan costs of $21,600 will not exceed the Social Security claim amount of $29,640.
But most homeowners likely won’t have the money to repay the loan immediately upon claiming full Social Security benefits unless they sell the home.
According to Social Security data from 2014, for people 65 and older, Social Security benefits account for 63 percent of their income. That proportion rises to 71 percent for beneficiaries who are 80 and older.
The alternatives to a reverse mortgage loan include:
- Working past 62, which can increase Social Security benefits by replacing years of low or no income from the homeowners’ record. Working longer also helps save more for retirement and pay off debt.
- For homeowners who are married, coordinating their claiming strategies with their spouses also may increase Social Security benefits.