028: Reducing Mortgage Debt & Downsizing
Aug 18, 2020
As you transition into retirement, you’re likely looking to understand how to reduce mortgage debt and downsize without burning through your savings. There are lots of ways to do it, and lots of important questions to ask along the way.
This is more true right now than ever before. With housing markets as hot as they are, it’s become very easy to downsize and end up spending more each month.
It’s critical that you do your homework, meet with your advisor and CPA, and determine exactly which tools are best suited to your situation. Today, we walk through some of the most common downsizing tools and strategies, with a focus on the HECM loan (also known as the reverse mortgage). You’ll discover how these loans work, why they aren’t a one-size-fits-all solution, and how they can provide you, under the right circumstances, with a sustainable source of money in retirement.
Here are just a handful of the things that we'll discuss:
- Why it’s so easy to lose money by downsizing.
- Why money received through a reverse mortgage is not taxable, does not affect your Social Security, and can’t impact means-testing for medicare.
- What happens to a reverse mortgaged home – and what beneficiaries will receive – when you pass away.
- How adult children living with you can impact your amount of available equity.
- Why the HECM loan is both key to a comfortable retirement for so many – and a bad fit for many people who ask about it.
- “Make sure that whatever tool you use – and a Reverse Mortgage is a tool – fits with your overall financial plan.” – Ed Siddell
- “We want to make sure that the people we’re helping are in the best financial shape possible. That’s the ultimate goal.” – Ed Siddell
Ed Siddell: So, reverse mortgage is a HECM loan and it stands for Home Equity Conversion loan. And so, what we look at how does it work, you have to look at the reverse mortgage. It is designed to basically what you’re doing is you’re converting the equity in your home to then turn around and pay off your mortgage so you don’t have to make any more mortgage payments.
Female: Being fit is about more than just a regular gym routine. When was the last time you checked on your financial fitness? If you’re feeling like you’re falling behind, Ed Siddell is here to help with The Retirement Trainer, a podcast about helping you get into better financial shape. Every week, Ed talks about things you need to know to become more financially fit for your future. Learn about things like how much money will you need, financial mistakes other people often make, and how you can avoid them plus details on the retirement fitness plan, a plan Ed personally created to help you get to and through retirement by focusing on five key areas of your financial life. Learn more about the retirement fitness plan when you visit EGSIFinancial.com and click on processes then subscribe, follow, and listen to The Retirement Trainer on Apple podcast, your iHeart app, or whichever podcast platform you prefer.
LeAnne Siddell: It’s The Retirement Trainer with Ed Siddell, a podcast about finding ways to help you become financially fit for your future no matter what shape you’re in now. As we enter this next phase in our life and transition into retirement, how do we reduce our mortgage debt if we have it? How do we downsize without spending all of our savings and what are the options? This is LeAnne Siddell and here to help us with all of our questions and maybe give us some guidance on how to stay in the best financial shape possible, the retirement trainer, Ed Siddell. Hi, Ed.
Ed Siddell: Hey, LeAnne. What’s going on? How are you?
LeAnne Siddell: Well, I’ll tell you, a lot of questions regarding this subject matter. I was actually really kind of enthused about you talking about downsizing and mortgage and everything else because it is a big subject for people.
Ed Siddell: Especially right now. I mean, with everything going on in COVID-19 and this housing market being so hot here in Columbus, I mean, it’s one of the hottest markets in all of North America.
LeAnne Siddell: Yeah.
Ed Siddell: So, yeah, it’s a double-edged sword. People are getting an awful lot of money for their homes but it’s becoming really expensive to downsize.
LeAnne Siddell: It is. So, with the crazy real estate market as it is currently right now, downsizing, is it more expensive, less expensive?
Ed Siddell: Well, it depends. Don’t you love when everyone starts an answer like that?
LeAnne Siddell: It’s like when people say, “That’s interesting.”
Ed Siddell: I mean, it really does and we’ve been through this with a lot of the families that we help and they’re downsizing and they have a huge house and they downsize to a house half the size. And they wind up paying more per month because of where they moved to. They have association, HOAs, different assessments, community fees, and the taxes are higher. So, it’s just like anything else. You need to make sure you do your homework but there are a couple of options as we talk about downsizing. And we did a podcast on that, right?
LeAnne Siddell: We did. When I was talking about some of the questions that still existed for me and that kind of resonated with you a little bit in the past, we’ve always seen the commercials out there, the reverse mortgage, all of this and I will say it’s a scary item when you have your parents talking to you about a reverse mortgage or these HECM loans. So, I think it’s a good subject to focus on just that in and of itself.
Ed Siddell: Sure. It’s just like anything else. There’s always if it’s on the internet, it’s always true, right?
LeAnne Siddell: Oh, my goodness.
Ed Siddell: There’s so much misinformation out there. So, let’s try and kind of clear up the muddy waters a little bit.
LeAnne Siddell: Perfect.
Ed Siddell: And by no means are we experts but with what we’ve dealt with, with the families that we’re helping and, in our experience, let’s just kind of go through and answer some of the basic questions. But the most important thing, before you do anything, do your homework, meet with your advisor, your CPA as well, and make sure that whatever you decide to do because what we’re talking about is just a tool, right? It’s just it’s no different, a reverse mortgage, a HECM, and I’ll explain what that is here in a minute, mutual funds, stocks, bonds, annuities, insurance policies, these are all just tools in the toolbox and there’s nothing that’s perfect. It all depends on how you use them to make sure that you can hit your goals and the best way to do that is to have a plan. And so, that’s really how you have to look at it. Okay. It’s not a be-all, end-all, and it’s not perfect.
LeAnne Siddell: Exactly. So, when you’re entering into this phase that we’re talking about right now, the biggest concerns are maintenance of the house, maintenance of the yard, all those things. So, that’s why downsizing comes into play in the first place. So, how do people swing it?
Ed Siddell: Well, first of all, so reverse mortgage is a HECM loan and it stands for Home Equity Conversion Loan. And so, what we look at how does it work, you have to look at the reverse mortgage. It is designed to basically what you’re doing is you’re converting the equity in your home to then turn around and pay off your mortgage so you don’t have to make any more mortgage payments. And it’s based on your age and we’ll talk about the qualifications here in a couple of minutes but it’s really designed so you don’t have to pay that mortgage payment to reduce your bills so that you can live retirement, make it a little bit better for you, and enjoy because that’s really what retirement is. You can supplement your income. So, if you have enough home equity, it can actually give you additional income on a monthly basis or you can use it as a home equity line of credit and the best part is you don’t have to pay any taxes on it. However, it is not a be-all, end-all so, again, buyer beware. You know, when you’re watching these commercials and everything and saying, “Oh my gosh, I can pay off all my credit cards. I can pay these medical bills. I can pay off my car,” or whatever it is, there’s rules that you have to follow because these are FHA insured loans.
LeAnne Siddell: Well, along that line, how do you qualify?
Ed Siddell: All right. So, you have to be 62 years of age. At least either one of the two spouses has to be 62 and you have to live there. So, it’s got to be your primary residence and you’re still responsible. Even if you qualify and you wind up doing the reverse mortgage, you’re still responsible to pay all the property taxes, the homeowners’ insurance, all the maintenance, and HOA fees, and any and all taxes because if you don’t, what will happen is they could call that loan due and payable and so then you’re going to have to refinance out of it.
LeAnne Siddell: So, how much can you get?
Ed Siddell: You know, it’s really going to depend because there’s a formula that they use and so the older you are, the more you can qualify for it because they use actuarial tables. And it’s not going to be the same amount for somebody who’s 62 as compared to somebody who’s 72 or 82 because again, the life expectancy. So, the older you are, the larger the amount of the home equity that you can draw upon. So, one of the biggest misconceptions is with a home equity line of credit as compared to a HECM loan, a home equity line, it’s already guaranteed, you know what that is upfront. So, it’s based on the value of your home if you have 30,000, 40,000, 50,000. Now, with a HECM loan, it’s already fixed. So, you already know going in, “Okay. I have a $200,000 home. I only owe 100,000 so I have 50% loan-to-value.” Now, if you’re in that situation and let’s say that you’re 62 and you have that $200,000 home and you owe $150,000, you may have to bring money to closing and actually use part of your savings to help cover that cost so that that way, you’re no longer going to have that mortgage payment but you’re still going to owe those taxes and insurance and dues.
LeAnne Siddell: Yeah. So, are there any costs? Are the costs different from a regular home equity loan or refinance of a mortgage?
Ed Siddell: They’re really not. I mean, remember, it’s FHA and so you’re still going to have the title insurance. You’re still going to owe the property taxes. Now, FHA is highly regulated so the amount of points or the fees on the loan, they have to qualify for it. So, they can’t overcharge you. And so, it’s really, really strict but it’s just going to be like a loan whether it’s a 15 or a 30-year traditional mortgage. The only difference is the rate is probably going to be a little bit higher, not much, but a little bit higher. Because remember, the way that these companies, these mortgage companies are making their money is on the equity on the back end. So, it’s just like ownership. So, one of the questions that everybody always asks is…
LeAnne Siddell: How does it make sense?
Ed Siddell: How does it make sense? Do I still own my home? Right? And you do, okay. And that’s why the loan-to-value or the amount of equity in your home is so important because they need to make sure at the end, that there’s enough equity in the home so that when both parties pass away, they can recoup their money. Because remember, let’s just say it’s 3.5% or 4% or whatever it is for that period of time until you pass away, it’s compounding. So, if you have a 50% loan-to-value and that’s what they did that reverse mortgage for so on the example that we use 200,000 and so you have $100,000 loan, and let’s just say you are 62, and you happen to live to 104 years old, well, when you sell that home, they’re betting on the fact that that home is going to continue to appreciate and hopefully, it won’t depreciate like the housing bubble in 2008, in which they’ll lose money. So, it’s kind of a risk on both sides. Now, everyone says, “Well, I don’t want to lose my home. I want to leave assets to my kids.”
In some, a lot of the families that we’re helping now are looking at it a little bit differently because they’re paying for college and college is so expensive, and they’re looking at it as we’re going to live our life. We’ve already paid for everything. They’ve already received their inheritance. We’re all here. And so, if there’s anything left over, great. So, in the example with a $200,000 home, if that loan, the original amount plus the compounding interest grows to $175,000 then the beneficiaries are going to receive the difference, which is the $25,000 when they sell it.
LeAnne Siddell: That was going to be my very next question. So, do they benefit off the appreciation or is there a possibility that your beneficiaries will still have something when the house is sold? So, that answered that question.
Ed Siddell: Yeah. And so, the family, the beneficiaries, they’re going to benefit more if the home appreciates. And the other thing is the disparity, so let’s just say that because we have a lot of families in which the one spouse is anywhere from 5 to 10, and we have a couple of 15 years older so it’s a big disparity. So, that loan is always based on the oldest bar. However, the youngest bar both have to be on the title. Alright, that is also taken into consideration as far as the amount that they’re going to lend because they want to make sure that they’re not paying out more than what eventually the home is going to be worth.
LeAnne Siddell: Makes sense. Yep. So, for those that are receiving money through a reverse mortgage, that was one of the options that you indicated that there could be where income is supplemented through a reverse mortgage, is that taxable?
Ed Siddell: That’s a great question and that’s actually one of the biggest questions that we get. It’s not because it’s your money. It’s your home equity. And a lot of people choose to take the additional equity as almost like an annuity payment every month or every quarter or every year so that they can depend on that money coming in. And the best part about that is unlike pretax retirement, whether it’s a traditional IRA, 401(k), thrift savings plan, 403(b), 457, whatever it is, when that money comes out, not only is it taxed as ordinary income but it could cause a spike in your social security and the means-based testing for Medicare B, C, and D. Well, the withdrawals because it’s the equity in your home and it’s not taxable, it’s not counted as taxable income so it doesn’t affect your Social Security or Medicare.
LeAnne Siddell: Well, and I’m pretty sure you really already touched on this as far as owning their home, but I kind of wanted to emphasize, do they still own their home? You talked a little bit about the fact that, yes, they do but I guess people are wanting to know, as far as again we’re talking about beneficiaries, when they pass away, what happens?
Ed Siddell: Yeah. I mean, it just goes to that’s why having an estate plan is so important in the trust and because you don’t want to go through probate. And so, that is going to determine, number one, who gets the proceeds, but it’s the value of the home plus the balance of the loan and it’s that difference that’s going to determine how much the family is going to get or the beneficiaries. Now, one of the things that we talked about is homeownership and I think this is kind of important because we also have a lot of families that we work with and help that have special needs kids or dependent children that have significant medical necessity.
LeAnne Siddell: And will be living with them for the rest of their lives.
Ed Siddell: Yeah. And just to clarify because I know that there’s been a lot of misinformation and we called and checked with a couple of sources, the big thing is just because they’re a dependent child doesn’t necessarily mean they get to live there forever. They have to be on title and they have to be on title at the time the HECM loan is taken out. Now, that age difference is also going to have a huge effect on the amount of the loan to value or the amount of the loan that the borrower is going to be able to take out.
LeAnne Siddell: Got it. Well, that’s all good information. What else should we know or should those that are listening know before they take a step in this direction?
Ed Siddell: I said in the beginning, it’s just like anything else, this is just a tool. It’s not a be-all, end-all. There’s absolutely nothing that’s perfect and it’s so important to meet with your financial planner, meet with your CPA, and make sure that this is a good fit for you. We have a lot of people that we’re helping that come in and ask. And for most of them, it’s not a good fit. I mean, it really isn’t. It does not meet their goals. And that doesn’t mean that it’s bad but it’s just like investing in certain stocks. I mean, it’s just not a good fit for what they’re trying to achieve. So, making sure that whatever tool that you use and a HECM reverse mortgage is a tool that it does fit your overall plan. For us, our mission and what we tell everybody all the time is we want to make sure that people we’re helping they’re in the best financial shape possible. I mean, that’s the ultimate goal because people have to have more confidence with their finances so that they can retire and enjoy it because retirement it’s all about cash flow.
And for a lot of people the reverse mortgage HECM, that is the only way that it’s going to make sense for them to enjoy retirement. And for some, it’s the only way that they actually can retire is to get rid of that mortgage debt, I mean, that monthly payment because some, it can be anywhere from $1,015, $2,000 a month that now all of a sudden that’s cash flow, and it is. It’s all about cash flow.
LeAnne Siddell: Well, that’s all great information. Thanks, Ed, very much. If people want to reach you, they can reach you by going to firstname.lastname@example.org or they can go to our website at EGSIFinancial.com. Give us a call at the office at 526-4118. But again, this is an opportunity for you to get some of these questions answered, set up a plan. Thanks, Ed, very much for your time.
Ed Siddell: Yeah. And that’s area code 614. Thanks, LeAnne.
Female: When was the last time you tested your fitness level? Not your workout routine. I’m talking about your financial endurance because if saving to a 401(k) is the extent of your effort, it is time for you to start shaping up and Ed Siddell is here to help you do that with The Retirement Trainer. It’s his podcast to help you examine your financial stamina and learn the questions you should be asking and areas to focus on to help you get to that place you’ve been working so hard for, a happy, comfortable retirement. And it’s not as hard as some might have made you believe. Ed’s broken it down into five simple steps. It’s the retirement fitness plan, which he personally created to help clarify key areas of your financial life. Learn more about the Retirement Fitness Plan at EGSIFinancial.com then subscribe, follow, and listen to The Retirement Trainer on Apple podcast, your iHeart app, or whichever podcast platform you prefer. Investment advisory service is offered through EGSI Investment Management dba EGSI Financial Group, a registered investment advisor. Insurance and annuity is offered through EGSI Financial Services, Inc. Ohio license number 1020619.