Boulder County home owners have seen the value of many of their investments decline so far this year, while most local real estate holdings have been moving upwards at a rapid clip. Talk of the Google effect continues nonstop among local real estate buyers and sellers. It’s reached such a fever that you would think that 1,500 stock option laden employees will drop out of the sky any moment ready with all cash offers with aggressive escalation clauses.
The reality is more sedate than this, of course. There are already more than 400 local Google employees, some of the new hires may already live in the area, and it’s unlikely that the new campus will be full on the day of opening. But it cannot be disputed that local real estate has been on a tear since early last year, with some homes increasing in value at a double digit rate.
Local home owners may feel elated as their home values increase, perhaps tinged with a bit a ruefulness that our area is growing increasingly less affordable. Let’s say your home has appreciated 20 percent in the last three years. How does that help your financial picture? Your home is a “use asset,” one that you consume every day by enjoying its shelter and comfort. If it goes through rapid appreciation, it improves your net worth but it does little to contribute to your ability to produce income to meet your goals of financial independence.
One way to unlock your home’s value is through downsizing. You sell your appreciated abode, taking advantage of tax-free gains, and then purchase a smaller and less expensive place. But many local homeowners have looked into their local downsizing options, and have not been impressed with the value in the mid-range part of the housing market in Boulder County. Are we doomed to be home equity carpetbaggers looking for a less expensive place to live?
If you’re dedicated to living in the local area, would like to stay in your home for a decade or more, have a lot of home equity, and are aged 62 or older, you may be a candidate for a Home Equity Conversion Mortgage (HECM) also known as a reverse mortgage. It’s like a traditional mortgage turned upside down. Instead of paying principal and interest on your mortgage every month, with a HECM you pay no interest or principal. Instead the reverse mortgage balance increases every month as interest accrues and you receive payments.
Let’s consider an example to see how this works. Imagine your spouse and you are 65 years old and own a $600,000 primary residence free and clear, but you’re experiencing cash flow problems. By taking out a HECM you could receive scheduled payments of $1,844 every month. This payment will continue for as long as one of you is living in your current house. There are no taxes due on this cash flow as it represents equity in your home. There are fees like any mortgage, and the $1,844 you receive every month is added to your HECM loan balance along with interest accruing at a variable rate.
Once you both are no longer living in the house for 12 months, then the HECM mortgage would need to be paid off to retain the home. In many cases the house would need to be sold to satisfy the HECM mortgage.
There’s good reason why HECM applicants must go through financial counseling. The decision to get a reverse mortgage is one that should be weighed very carefully. You should plan to live in your home for a decade or more, assume that your heirs will not be able to retain the house, understand the downsides of a variable interest rate, and be able to shop options from different lenders that can feature different closing costs and terms. Other options such as downsizing and intra-family mortgages should also be explored.
HECM reverse mortgages are not a panacea, but do offer an option to age in place with your home equity generating cash flow. Your heirs may receive less, but you may find that they would prefer you to age with fewer cash flow concerns than for them to inherit a free and clear home.
David Gardner is a certified financial planner with a practice in Boulder County and can be reached with questions at dave[email protected] and on Twitter @Dave_CFP
Reverse Mortgages are Brokered Products.
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