Equity going backward
With reverse mortgages, money flows in the opposite direction from a typical mortgage -- your lender pays you. Rather than slowly gaining equity in your property, your equity is likely to go down over time.

There are two reasons for this. First, if you take a monthly payment, then each month, you'll add to the outstanding balance of the loan. Second, as with any other loan, your lender will charge you interest on that balance. If your total loan balance grows faster than the value of your property -- which is certainly possible, especially with home prices falling dramatically in many parts of the country -- then you'll have less equity.

Traps for the unwary
While reverse mortgages can give you an easy way to get to your home's equity, you should understand a few things when considering them:

• Even if your home is paid off completely, you won't be able to borrow the full value of it. For instance, you may only qualify for a $125,000 loan on a home worth $200,000.
• Moreover, closing costs can be substantial -- well above what you'd pay on a typical mortgage. Fees and closing costs may total over $16,500, leaving you with a lump sum of less than $108,500.
• In general, the older you are and the more your home is worth, the more you'll be able to get from a reverse mortgage. 
• The lender will collect the principal when you sell your home, pass away, or move to another primary residence, such as a nursing home.

Longevity Annuity Instead

Instead of relying on the equity value in your home to help you in retirement, why not set up a guaranteed stream of income via a Longevity Annuity while you’re saving for retirement?  Then you don’t have to worry about plunging real estate values or that you’ll need to sell your home to pay the lender, should your situation change. 

Longevity Annuities are not affected by the real estate or stock market, and as long as you choose a solid company to back the guaranteed stream of income, you should be able to sleep better at night, than if you were to settle for a reverse mortgage.  The Annuity will likely require much less up-front capital to provide the same stream of income that the reverse mortgage promises.

For instance, if you require $1,500 per month to supplement your retirement income beginning at age 75, you could pay $24,000 into a longevity annuity, at age 50.  That $1,500 monthly payment will continue as long as you live, will increase by 3% each year, and doesn’t reduce the amount of equity in your home or charge you any interest.  On the other hand, the $108,000 provided by the reverse mortgage, would last about 6 years if you match the payment of the Longevity Annuity. 

If you don’t have $24,000 on hand, why not reduce your annual 401(k) contributions, which will be fully taxed when you spend the money in retirement, and use a portion of that contribution to set up a Longevity Annuity, whose payment in retirement is only partially taxed.  If you have longevity in your blood, a Longevity Annuity makes much more sense than a reverse mortgage, in most cases!

Although you should keep these thoughts in mind, a reverse mortgage still might be a useful part of your financial plan for your retirement years. If you'd like to learn more, help yourself to a complimentary 30-day guest pass to Rule Your Retirement. You'll get access to back issues and much more. It's free, with no obligation to subscribe.

Liz Garcia, DeHayes Consulting Group

Dan Caplinger, TMF Galagan

Please consult your tax advisor and financial planner to ensure which strategy is best for you.