A rose by any other name may smell just as sweet, but when it comes to home equity loans, one that is labeled "reverse mortgage" just plain stinks.
That's the conclusion of new research released Wednesday by the National Council on Aging, a nonprofit advocacy group supporting older adults. Like it or not, finding ways to unlock home equity may hold the key to retirement security for many aging baby boomers.
The research was designed to gauge the interest in and understanding of home equity products among both older homeowners and financial advisers. It included comprehensive surveys of more than 250 financial advisers and more than 1,000 older homeowners ages 60-75, plus focus groups with 112 consumers. It turns out that consumers and advisers are equally uninformed about the nuances of the various ways to tap home equity.
More than 90% of older consumers worry about rising medical costs in retirement and more than 80% worry about outliving their retirement savings, according to the research. Yet when considering financial preparedness, consumers focused primarily on accumulated assets such as 401(k) accounts, pensions, annuities and savings. Even though their homes can represent as much as 80% of their net worth, older people generally overlooked or were unwilling to consider home equity as a retirement asset.
The research also revealed that neither consumers nor financial advisers have a full understanding of two common home equity products — a home equity line of credit and a reverse mortgage line of credit. Survey participants were presented with descriptions of both types of loans and asked which one best met their retirement needs.
Participants were told that loan A allows a borrower to access a line of credit for 10 years and requires minimum monthly payments, and the loan balance must be repaid in full even if the borrower owes more than the house is worth. Loan B has no mandatory 10-year draw period, requires no minimum payments and the borrowers or heirs never pay back more than the home's fair market value when sold.
When the products were described, but not named, 58% of consumers and 43% of financial advisers said they preferred Loan B, which is a reverse mortgage. But when both products were named, 68% of consumers and 37% of financial advisers flip-flopped and said they preferred a home equity line of credit.
"Older homeowners and financial advisers have a strong negative bias against the reverse mortgage line of credit based exclusively on product name and driven by preconceived notions and misunderstanding of the product," the NCOA study found. (Full disclosure: I am a paid consultant to the NCOA).
"When it comes to retirement, it is not a question of [whether] older adult homeowners will access home equity, it's a matter of when, and more importantly, how," said Craig Corn, CEO of Reverse Mortgage Funding, which funded the research through a grant to the NCOA.
"Optimizing the value of the home is central — not peripheral — to the decumulation phase," added Jay Greenberg, CEO of NCOA Services, a subsidiary of the NCOA.
Typically, a home equity line of credit, commonly called a HELOC, has a 10-year interest-only feature, but begins to amortize after that. "Think of what might happen to a 65-year-old who takes out a HELOC and 10 years from now their monthly payment goes from $300 per month to $700 per month when they can least afford it," Mr. Corn said. "With a reverse mortgage, the borrower can decide whether to make a payment or not." The reverse mortgage must be repaid when the homeowner leaves the house permanently or dies.
(Questions about new Social Security rules? Find the answers in my new ebook.)
Mary Beth Franklin is a certified financial planner.
