Reverse-Mortgage Home-buying

Submitted by Rick Kahler on Friday, March 30, 2012 - 9:00am
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Here’s a novel use for a reverse mortgages: to buy a new house. Most people use reverse mortgages to produce income for life – through tapping the equity in their old houses. But there are more creative alternatives, says financial advisor Michael Kitces.
 
While most think of a reverse mortgage as a way to unlock equity in a current home without having to sell it, Kitces shows how to use it for home-buying. The downside is that the buyer needs a larger-than-normal down payment due to the lower lump-sum limits of a reverse mortgage. Still, this technique can increase cash flow while downsizing to a smaller home.
 
Here is how this works. A couple owns a house worth $300,000 with a $125,000 first mortgage. The monthly payment is $800. They want to move to a smaller home costing $200,000. One option is to sell the current home and use the proceeds of $175,000 to buy the new one, obtaining a traditional $25,000 loan with a $200 monthly payment.
 
Another possibility would be to use $100,000 of the sale proceeds as a down payment on the new home and finance the remaining $100,000 via a reverse mortgage. The balance of the proceeds of $75,000 could go into an investment portfolio and, if it returns around 5% yearly, generate $300 a month.
 
This eliminates the house payment and also increases their monthly income. The result is an increase in available cash of $1,100 a month over staying in the current home (the $300 in investment income plus the $800 they no longer need pay for the mortgage) and $500 a month over selling the home and obtaining a traditional mortgage for the new house. The owners would get to live in the property until death or they moved out. They also would still have $100,000 of equity in the house if they did need to sell it.
 
Still another option, which I touched on previously, is to supplement your monthly cash flow with a reverse mortgage long before you’ve depleted all your assets. By using a reverse mortgage early on, homeowners may be able to preserve and extend their liquid reserve.
 
Because payments from a reverse mortgage do not increase with inflation, and because they use up home equity for current living expenses, a reverse mortgage is always a strategy to be evaluated carefully.
 
Thus you need to be careful not to begin receiving reverse mortgage payments too early. The youngest you can be to apply for a reverse mortgage is age 62, but in most cases it may be best to wait until you are in your 70s or 80s. The longer you wait, the higher the monthly payment.
 
A reverse mortgage is not for everyone. Used wisely and appropriately, however, it may make a difference in extending your standard of living for many more years and possibly for the rest of your life.
 
Rick Kahler, CFP, is president of Kahler Financial Group in Rapid City, S.D.
 
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