It is a common wisdom that once you retire; you need to cut back on your lifestyle. However, this need not be the case. Currently, there are a good number of programs available which if used judiciously can help a household maintain its living standard in retirement. One of the ideal choices is the reverse mortgage program called Home Equity Conversion Mortgage (HECM) under the wings of Federal Housing Administration (FHA).
It helps in converting the equity in the house built by the owners during their working life into cash. This cash is available using different payment mechanism like tenure payment, term payment, line of credit, and more.
We will look at how to use the reverse mortgage along with social security to get an ideal living standard during retirement. Our calculation and analysis will show that even a median or lower earning family can easily maintain their living standard provided they use their assets and options carefully.
Social security received during old age is one of the chief income sources for retired individuals. One of the central points of social security payments is that the later an individual starts receiving the payments the higher will be the payments. If we take a general case of an individual who was born between 1943 and 1954, a full or normal retirement age is 66 years.
The payout for this individual is:
|Age at which social security payments are started||Retirement benefit in PERCENTAGE|
If an individual is to receive a social security payment of $1000/month at full retirement (66 years) he/she will receive $750/month if they start at 62 years or $1320/month if they start at 70 years.
Hence, there is an overall increase of $570/month if the payments are delayed by 8 years. The actual increase will also take the Cost-of-living adjustments (COLA) into account. This means that the purchasing value of money will remain the same even if the payments are delayed.
For an individual or household it might not be possible to delay these payments. Especially if there is an actual retirement from work and there is no additional income. Here the HECM program can come in handy for the family to bolster their income and meet the expenses before the full social security payments start. Let us look at a scenario to see the actual financial calculations for the household.
Bill and Mary are both 61 years old. They both have had long careers and plan to retire when they reach 62 years old. They currently reside in their home which they have owned for the past 30 years and plan to retire in this house. It is currently valued at $250,000. Both of them have led a healthy life and would like to have a comfortable lifestyle during their old age. The full retirement age for both is 66 years, but they plan to delay their social security benefits to get a higher payout. During this time, they plan on using the HECM program to maintain their lifestyle. According to their calculation Bill will get $1400/month, and Mary will get $1000/month as social security if they take it at the full retirement age of 66 years.
They can apply for reverse mortgage on their house with term period payment of 8 years. They will be eligible to apply once both of them are 62 years old. After 8 years both of them will be 70 years when they can start the social security benefits.
For the reverse mortgage following are the main points:
|Appraised cost of house||$250,000|
|Interest rate charge||2.154%|
|Net Principal available||$129,041|
|Term period||8 years|
|Additional line of credit||$0|
The household will receive $1,642/month for the next 8 years if they enter HECM program when they turn 62 years. All the requirements and eligibility for reverse mortgage should be thoroughly reviewed by every homeowner before using this program.
When Bill and Mary reach 70 years their social security payments will start at the maximum payout level. For Bill the payout is $1,400*1.32= $1,848. The payout for Mary will be $1000*1.32=$1,320. The total payout will be $3,168/month for the family. (The 32% increment for both the individuals is because they have delayed their social security payments by 4 years from the date of full retirement age of 66 years)
If they were to use their social security benefits directly at 62 years, the payment for Bill will be $1400*0.75= $1050. For Mary, it will be $1000*0.75=$750. The total payments will be $1800/month for the rest of their life. (25% decrease for both the individuals is because they started taking the benefits before the full retirement age)
When using a reverse mortgage the couple will receive $1642/month from 62 to 70 years of age. After 70 years, they will receive $3168/month through social security benefits. Without reverse mortgage, they will receive $1800/month through social security.
For this couple, the reverse mortgage option has significant advantages. From 62 to 70 years one or both the individuals might continue with partial employment or they can use other assets to bolster their income. The expense on health might increase in their 70s and 80s during which time the higher social security benefit will be helpful for a couple. They plan to stay in the same house during retirement and hence reverse mortgage would not be an issue. Although they are losing equity in their house by using a reverse mortgage, they are getting a significant hike in benefits by delaying the payments. The benefits are $1368/month or $16,416/year. This can be a major benefit during the old age for a couple.
Figure: Share of income from social security for households over 65 years divided into five parts according to their income. Source: Social Security Administration, 2012, Table 10.5
We can see that for the majority of households social security is the major income source during retirement. However with careful planning it is possible to utilize this program in a much more beneficial manner which can help to provide a better living standard in old age and the ability to take care of one’s needs.