How seniors can finance "upsizing" to a new home

Not all retirees are ready to downsize their homes to reduce costs. While some may want to stay put, others are actually looking to move up to a more desirable home, for any number of reasons. 

For instance, they might want to move closer to adult children and grandchildren who live in a more expensive area. They might want more space for friends and family to visit. Or they may want room for a workshop, artist space, or yoga studio.

Seniors with significant home equity can combine that asset with a reverse mortgage to buy a more expensive home without incurring a monthly mortgage payment. Sound too good to be true? Let’s take a look at an example prepared by Reverse Mortgage Funding (RMF), one of the nation’s largest Ginnie Mae issuers of reverse mortgages.

Suppose a 62-year-old couple owns a mortgage-free home worth $300,000. Their adult children and grandchildren live in a metropolitan area where home prices are higher, and the couple wants to live close by. But they don’t want to assume a conventional mortgage with monthly principal and interest payments because they feel the extra monthly expense would put a severe crimp in their retirement budget. 

They sell their $300,000 home as a “for sale by owner” and buy a new home for $450,000. They make a down payment of 52 percent ($234,000) of the new home’s sale price using proceeds from selling their house, and they finance the rest of the new house ($216,000) with a “reverse mortgage for purchase.” 

In the process, they could pocket up to $66,000 from the home they sold. This amount would be reduced by any closing costs on the sale of their current home. In particular, if they sold the home through a realtor, the commission could be several thousand dollars and would reduce their net gain.

The reverse mortgage loan doesn’t need to be repaid until they sell the new home, pass away or move out, providing all other loan obligations are met, such as property taxes, insurance and maintenance. And the “nonrecourse” feature of an Federal Housing Authority-insured reverse mortgage guarantees that they’ll never owe more than the new home is worth when the loan is repaid.

Of course, the reverse mortgage has closing costs that need to be considered. Assumptions in the above example are that the interest rate is 4.5 percent with a 6.18 percent APR, no loan-origination fee, third-party closing costs of $8,417 and a 2.5 percent upfront FHA mortgage insurance premium of $11,250. Total up-front closing costs add up to $19,667, or 9 percent of the loan value.

With the exception of a $125 fee for third-party reverse mortgage counseling, which the borrowers pay directly to the counseling agency, these closing costs are financed by the reverse mortgage loan. Of course, the cost details in this example are for illustrative purposes. Interest rates, funds available and terms and conditions may change daily without notice.

As this example shows, reverse mortgages can have higher interest rates and closing costs than conventional mortgages. So retirees will need to consider whether these costs are an acceptable price to pay for the satisfaction and joy they’ll realize by upsizing, while having the option of no monthly principal and interest payments.

What happens to their original $234,000 of home equity that they invest in the new home? When they eventually sell the house or pass away, the home will be sold at the then-current market value. The loan balance of the reverse mortgage -- which includes those original closing costs and accumulated interest -- will be deducted from the sale proceeds, as will any closing costs or real estate commission on the sale of the new home. 

Any residual value is available for a legacy.

If the new home appreciates at roughly the same rate as the reverse mortgage interest rate, the home equity will remain roughly intact, reduced by the reverse mortgage closing costs.

If the new home appreciates at a lower rate than the reverse mortgage interest rate, the original home equity will be eroded, but the couple will never be underwater due to the nonrecourse loan feature.

If the new home appreciates at a higher rate than the reverse mortgage interest rate, the amount of home equity could grow.

Obviously, this type of transaction isn’t right for everybody. However, for many seniors, the “reverse mortgage for purchase” transaction might be one way to upsize if they agree that it will make a substantial improvement in the rest of their lives.

This is just one way retirees can use reverse mortgages to tap their accumulated home equity. Retirees can also use reverse mortgages to:

  • Generate regular monthly cash flow (like an annuity).
  • Stay in their current home but retire a conventional mortgage to be free of monthly principal and interest payments. As homeowners, they’ll still be responsible for keeping current with property taxes, insurance and maintenance as part of their ongoing loan obligations.
  • Coordinate with a systematic withdrawal plan that uses invested assets to generate monthly cash flow and tap a reverse mortgage line of credit only when invested assets have depreciated (thereby mitigating so-called sequence-of-returns risk).
  • Take out a reverse mortgage line of credit to build a resource that can be tapped in the future, say for long-term care expenses.

According to one study, Americans of all ages have almost as much home equity as they hold in accumulated retirement savings. In fact, many seniors are approaching their retirement years with substantial home equity and possibly modest retirement savings or retirement income. It’s just common sense to consider how all your assets can be deployed to finance the rest of your life.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.