A home equity conversion mortgage (HECM) might simply be a fancy term for a reverse mortgage, but there are an increasing number of advisors and planners who are using them for an entirely different strategic planning purpose.
If you ask most couples in their sixties and beyond what is one of the greatest fears for their future, I’m betting that going bankrupt and/or losing their home and life savings as a result of nursing home bills would be right up there near the top.
We all have horror stories to tell of how one or both spouses needed to go into a nursing home and the costs drained all their assets and then some. Before they could apply for Medicaid, they had to go through everything they own—their home, their retirement and savings accounts—all gone. Only then could they qualify for government assistance, which usually means and ending up on a Medicaid waiting list for a remote, tiny room in a facility for the remainder of their lives.
That, my dear reader, is not the kind of “living the dream” Americans have in mind when they think of their future retirement years. Now, of course, the knee-jerk answer to this ever-present nightmare is long-term care insurance Any financial planner worth their salt will tell the average consumer to buy insurance, but there is lots of downside in following that avenue.
Let’s take a sixty-five-year-old couple shopping around for this insurance. For the male, it will probably cost him double what it will cost his wife. A premium per month of $4,543.76, while the wife pays $2,825.97. That comes to $7,369.73 per year for the couple. And that is only if their health qualifies them for insurance in the first place. These are not fictitious numbers, but taken from a recent Cross Insurance estimate for these 65-year-old sample customers.
In exchange, you get three years of coverage, with a $5,000 monthly benefit (up to $180,000 total) in home care benefits. You will then have to re-new the policy every three years (most likely at higher premiums), regardless of whether or not you used the coverage. For a retired couple watching their finances, and living off Social Security and hopefully, some retirement savings, that’s a fairly high expense. In addition, there are many facilities that charge far more than $5,000/month for the care they give.
However, over the past few years, a number of financial planners have discovered a way to tap into a retiree’s home equity in the event that the worst happens and one or the other of you needs outside care. In its simplest form, a couple (of which at least one must be 62 years of age or older), can take out a HECM, or what amounts to a reverse mortgage. But instead of receiving a standard monthly payment, you elect not to take these distributions until the day you need the money to pay for outside nursing care.
Let’s take an example where you own your own home, debt-free, worth $500,000. The mortgage company does an appraisal and determines they will loan you half of the amount in an HECM. Like any mortgage, you will be charged fees (origination fees, third party fees, etc.) which comes to about $17,000 or about 7-8% of the loan. Like any mortgage, you are still responsible for paying the taxes on the home while continuing to maintain the dwelling, etc.
Those payments you would normally receive from a traditional reverse mortgage are, instead, accumulated in your account at the mortgage company year after year. Think of them as a credit line, which grows and grows. Every year they accumulate, you are paid a half percentage point per annum above the yearly London Inter-bank Offered Rate (LIBOR interest rate). Currently, Libor is trading at about 4.5%, plus the half point that you receive above that equates to about 5%. These payments to your account accumulate at this risk-free rate until you use them.
Better still, the underlying worth of your house can go up or down but has no impact on your future payments. The primary risk you take is that LIBOR fluctuates, causing the payments you receive to rise or fall over time.
The payments keep working for you until such a time you need them. At some point, the inevitable may occur. One or both spouses needs some form of assisted living. In that case, you simply direct the mortgage company to begin paying monthly sums. If you want, you could request the reverse mortgage payments correspond with the monthly expense of the nursing home. Best of all, these payments are tax-free.
As long as one spouse remains in the home, the house is still yours until the spouse dies or has not lived in the property for the last 12 months. At that point, the house reverts to the mortgage company. If, in the meantime, you still have equity in your home, your beneficiaries receive the remaining proceeds.
But what if you never need to go into a nursing home? Conceivably, the credit line you have accumulated can grow until it exceeds the value of your home. If so, you simply call the company and ask them to cut a check for part or all of your credit line. The point is that the HECM is your long-term care insurance, but it pays you rather than the reverse. Your spouse keeps the house, the Social Security payments, the retirement savings, etc. just like before.
In my next column, we will examine other uses of a HECM and dig into the details of the long-term care concept. Stay tuned.