Do you have enough home equity to pay for long-term care in retirement?
A home equity conversion mortgage (HECM) might simply be a fancy term for a reverse mortgage, but there are an increasing number of advisers and planners who are using them for an entirely different strategic planning purpose.
If you ask most couples in their 60s and beyond what is one of the greatest fears for their future, I'm betting that going bankrupt and/or losing their home and life savings as a result of nursing home bills would be right up there near the top.
We all have heard horror stories. One or both spouses needed to go into a nursing home, and the costs drained all their assets and then some. Or you may have heard of a couple that couldn't apply for Medicaid until they had gone through everything they own — their home, their retirement and savings accounts — all gone.
That, my dear reader, is not the kind of "living the dream" Americans have in mind when they think of their future retirement years. Now, of course, the knee-jerk answer to this ever-present nightmare is long-term care insurance. Any financial planner worth their salt will tell the average consumer to buy insurance, but there are lots of downside in following that avenue.
Let's take a 65-year-old couple shopping around for this insurance. For the male, it will probably cost him double what it will cost his wife. He will pay a premium of $4,500, while the wife pays $2,800. That comes to $7,300 per year for the couple. And that is only if their health qualifies them for insurance in the first place. These are not fictitious numbers, but taken from a recent Cross Insurance estimate for these 65-year-old sample customers.
In exchange, for that they'd get three years of coverage, with a $5,000 monthly benefit — up to $180,000 total — in home care benefits. They will have to renew the policy every three years — most likely at higher premiums— regardless of whether or not they used their coverage.
For a retired couple watching their finances, and living off Social Security and hopefully, some retirement savings, that's a fairly high expense. In addition, there are many facilities that charge far more than $5,000/month for the care they give.
However, over the past few years, a number of financial planners have discovered a way to tap into a retiree's home equity in the event that the worst happens and one or the other of you needs outside care.
In its simplest form, a couple — of which at least one must be 62 years of age or older — can take out a HECM, or what amounts to a reverse mortgage. But instead of receiving a standard monthly payment, you elect not to take these distributions until the day you need the money to pay for outside nursing care.
Let's take an example where a person owns their own home, debt-free, worth $500,000. The mortgage company does an appraisal and determines they will loan the homeowner half of the amount in an HECM. Like any mortgage, the person will be charged fees — origination fees, third-party fees, etc. — which comes to about $17,000, or about 7 percent to 8 percent of the loan. Like any mortgage, the homeowner is still responsible for paying the taxes on the home while continuing to maintain the dwelling.
Those payments the homeowner would normally receive from a traditional reverse mortgage are, instead, accumulated in an account at the mortgage company year after year. Think of them as a credit line, which grows and grows. Every year they accumulate, the client is paid a half percentage point per annum above the yearly London Inter-bank Offered Rate (LIBOR interest rate). Currently, LIBOR is trading at about 4.5 percent, plus the half point that you receive above that equates to about 5 percent. These payments to your account accumulate at this risk-free rate until you use them.
Better still, the underlying worth of your house can go up or down, but has no impact on your future payments. The primary risk you take is that LIBOR fluctuates, causing the payments you receive to rise or fall over time.
The payments keep collecting interest until such a time as they are needed. At some point, the inevitable may occur. One or both spouses needs some form of assisted living. In that case, a person can contact the mortgage company to begin paying monthly sums.
If you want, you could request that the reverse mortgage payments correspond with the monthly expense of the nursing home. Best of all, these payments are tax-free.
As long as one spouse remains in the home, the house is still yours until the spouse dies or has not lived in the property for the last 12 months. At that point, the house reverts to the mortgage company. If, in the meantime, you still have equity in your home, your beneficiaries receive the remaining proceeds.
But what if you never need to go into a nursing home? Conceivably, the credit line you have accumulated can grow until it exceeds the value of your home. If so, you simply call the company and ask them to cut a check for part or all of your credit line. The point is that the HECM is your long-term care insurance, but it pays you rather than the reverse. Your spouse keeps the house, the Social Security payments, the retirement savings, etc., just like before.
Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Schmick's forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 888-232-6072 (toll-free), or email him at firstname.lastname@example.org.
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