One way for you to potentially improve your cash flow during retirement is to use a home equity conversion mortgage (also known as a "HECM" or "reverse mortgage"). The HECM is a mortgage loan made by a private lending institution such as a bank, credit union or mortgage company. The loan is insured by the Federal Housing Administration (FHA), which is a division of the US government. You are not required to make monthly mortgage payments, and any interest that you owe is simply added to your loan amount. Here's how it works:
- Assume you are 62 years old and your home is worth $500,000. You would likely qualify for a loan in the $250,000 range. So you'd still have about $250,000 of equity remaining in the home (see illustration). The $250,000 can be used to pay off other debts and eliminate the payments associated with those debts. Or you could use the funds for any other reason.
- Your home would continue to go up or down in value, taking your equity position right along with it. However, the HECM balance would also be growing over time. So in this example, if the home goes up in value to $600,000, and the HECM balance grows to $350,000, your equity in the home would remain constant at $250,000. If you use the line of credit version of the HECM, the credit limit on your line of credit would increase every year. This would give you immediate access to your home equity at any time that you need it.
- In the worst case scenario, let’s assume the home doesn’t go up in value, and the HECM balance continues to grow throughout your lifetime. By the time you sell the home, assume the HECM balance is greater than the value of the property. In this example, the home would only be worth $500,000 and the HECM balance is $600,000, which is $100,000 more than the value of the home. The FHA would eat the loss. That’s why the FHA charges mortgage insurance on the loan. The FHA mortgage insurance covers you and your estate from a potential negative equity scenario in the future.
A HECM can be used to improve cash flow and give you more financial options than you previously thought were available.