This is a summary of an article written by my education partner, Dr. Wade Pfau. The full article can be found here.

 

Reverse mortgages have long carried a negative reputation, largely due to past misuse and misunderstandings and partly because of lingering misconceptions about how these products work. While government reforms in recent years have introduced new protections and spending limits, making reverse mortgages safer and more transparent, many advisors and clients may still feel cautious about them.

Understanding the history behind this perception—and the current facts—can help advisors better discuss reverse mortgages with their clients and recognize when they may be an appropriate option in a retirement income strategy.

Key Reasons for the Negative Reputation

Reverse mortgages gained a poor reputation for a few primary reasons, including misuse by borrowers, misunderstandings among family members, and challenges for non-borrowing spouses.

Let’s look at these issues in more detail.

• Misuse of Funds: In earlier years, some retirees took out reverse mortgages and spent the available funds quickly on discretionary expenses or even risky or fraudulent investments. This approach left them with reduced home equity, often sooner than they expected, and compromised their financial security later in life. Using reverse mortgages irresponsibly contributed to the perception of these loans as high-risk.
• Family Misunderstandings: Many families have faced tension when adult children assumed they’d inherit their parents’ home, unaware that reverse mortgages require repayment upon the homeowner’s death. Some children were left frustrated or disappointed, assuming their inheritance had been taken by the lender. In reality, heirs can still inherit the home by repaying the loan balance, but this aspect is often misunderstood. Strategic use of reverse mortgages can even increase legacy wealth when used effectively to cover retirement spending needs.
• Non-Borrowing Spouse Vulnerability: Previously, a non-borrowing spouse—often a younger spouse who was removed from the home title to qualify—was left vulnerable if the borrowing spouse passed away. They would face the choice of repaying the loan or vacating the home. This issue compounded the negative reputation of reverse mortgages as a potentially harmful product for certain households.
• Home Title Confusion: Many people mistakenly believe that lenders take ownership of the home in a reverse mortgage. This is not true; the homeowner retains title ownership, with the lender only holding a lien to ensure repayment. Yet, this persistent myth still influences negative perceptions around reverse mortgages.

Government Reforms to Address Concerns

Over time, the U.S. Department of Housing and Urban Development (HUD) has enacted regulations to promote more responsible use of reverse mortgages and address key issues.

• Spending Limits: As of recent years, HUD restricts borrowers from accessing more than 60% of the loan amount within the first year. This helps encourage more cautious use of funds, allowing home equity to serve as a longer-term resource rather than being depleted quickly.
• Mandatory Counseling: Borrowers must undergo counseling to understand the terms and potential implications of a reverse mortgage before proceeding. This counseling ensures they can make informed decisions and use reverse mortgages strategically.
• Non-Borrowing Spouse Protections: Since 2015, new protections allow non-borrowing spouses to remain in the home even after the borrowing spouse has passed. This protection reduces the risk of displacement, although the non-borrowing spouse cannot draw further from the loan’s line of credit.

These protections have gone a long way toward making reverse mortgages a more sustainable and responsible tool for retirement.

Academic Highlights:
Dr. Wade Pfau on Reverse Mortgages

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Additional Concerns: Costs and Stigma

Beyond issues of misuse and family misunderstandings, two more factors contribute to the skepticism around reverse mortgages: their initial costs and the general stigma around using debt in retirement.

• High Costs: In the past, reverse mortgages came with hefty upfront costs, sometimes reaching as high as 6% of the home’s value. Over time, these costs have decreased significantly, with competitive lenders offering lower fees today. While a 0.5% upfront mortgage insurance premium is standard, borrowers should still shop around to compare lenders and find the best terms for their needs. Closing costs related to home appraisal, title fees, and more may be unavoidable, similar to traditional mortgages, but can vary from lender to lender.
• Debt Aversion in Retirement: Many retirees feel uncomfortable with debt, as they have spent much of their lives working to reduce it. Taking on a reverse mortgage may feel counterintuitive to the goal of a debt-free retirement. However, by framing a reverse mortgage as a way to access home equity rather than an additional liability, retirees can view it as creating liquidity from a non-liquid asset. It provides an income source without requiring the sale of the home, turning home equity into an accessible resource for retirement expenses.

Reframing Reverse Mortgages as a Retirement Tool

With modern safeguards in place, reverse mortgages can play a valuable role in retirement planning for some clients. Used responsibly, they allow retirees to tap into home equity, making it a liquid asset that can enhance retirement income and provide flexibility in managing expenses. Although challenges remain, government regulations have addressed many key concerns, improving transparency and making reverse mortgages a more reliable option.

By understanding these benefits and protections, advisors can help clients determine whether a reverse mortgage could be a smart addition to their retirement income strategy. As more financial professionals become educated about the potential value of reverse mortgages, this tool may gain broader acceptance as a viable way to support financial security in retirement.

Growing Acceptance by Financial Thought Leaders, Academic Institutions, and Publications

In recent years, reverse mortgages have gained traction as a viable financial planning tool, endorsed by respected thought leaders, academic institutions, and prominent publications. This growing acceptance stems from a recognition that, when used strategically, reverse mortgages can help optimize retirement income, manage sequence-of-returns risk, and provide financial flexibility. Experts and researchers have found that including home equity in retirement income strategies can potentially improve outcomes, especially when other assets are under pressure.

• Academic Institutions: The American College of Financial Services has extensively researched reverse mortgages, with thought leaders like Dr. Wade Pfau leading the charge. In his studies, Pfau found that reverse mortgages, when strategically incorporated, can reduce retirement portfolio risk, improve longevity, and mitigate the impact of market downturns on liquid assets. His groundbreaking work, including publications such as “Using Reverse Mortgages in Retirement Income Planning,” has become an essential resource for advisors seeking to understand the nuanced benefits of reverse mortgages (Pfau, 2016).
• Prominent Publications: Reverse mortgages have also received positive coverage in influential financial publications. Forbes has featured numerous articles by Dr. Wade Pfau and others, discussing how reverse mortgages can be used to support retirement income while dispelling common misconceptions. In The Wall Street Journal, researchers emphasized that reverse mortgages can offer retirees a “buffer asset,” allowing them to avoid tapping their portfolio in unfavorable market conditions (Tergesen, 2015).
• Industry Thought Leaders: Leading financial experts like Tom Hegna and Dr. Harold Evensky have publicly endorsed the responsible use of reverse mortgages as part of a holistic retirement plan. Dr. Evensky, often credited with pioneering the “bucket strategy” for retirement income, has stated that reverse mortgages are “very effective and helpful” for retirees seeking greater income security. He has advocated for their use as a valuable risk management tool that can stabilize income, especially in volatile markets (Evensky, 2013).

This acceptance underscores the potential of reverse mortgages as a flexible, adaptable retirement resource when used thoughtfully. By aligning with industry research and thought leadership, financial advisors can better understand and advocate for reverse mortgages as a legitimate and valuable tool in comprehensive retirement planning.

References:

• Pfau, W. (2016). “Using Reverse Mortgages in Retirement Income Planning.” The American College of Financial Services.
• Tergesen, A. (2015). “Retirees Are Turning to Reverse Mortgages for Funds, but at a Cost.” The Wall Street Journal.
• Evensky, H. (2013). “The Case for Reverse Mortgages in Retirement Planning.” Journal of Financial Planning.

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Taking the Spooky Out of Reverse Mortgages
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Tom Hegna, Don Graves, Dr. Wade Pfau