Reverse mortgage or trading down--which is better in retirement?

Posted by  on Dec 13, 2010

Earlier this year, the Society of Actuaries (SOA) published the findings of surveys it conducted in 2007 and 2009 into retirement in America. And it found that one-fifth of retirees planned to trade down their home, either to a smaller property or by moving to a less expensive area. Meanwhile, something close to a quarter of those approaching retirement were n6t expecting to be free of their mortgage when their big day came and they left the workforce.

Trading down today a problem

There's a problem for those who want to trade down: this isn't a good market in which to do so. When prices are falling (as they still are in many parts of the country), a drop of, say, 10 percent on a property worth $500,000 means a fall of $50,000, while the same percentage reduction on one worth $200,000 produces a price that's just $20,000 lower.

So someone who had hoped to trade down their half-million dollar home for a $200K one, and pocket $300,000, could actually find themselves selling for $450,000 and buying for $180,000, giving them just $270,000. That 10 percent represents a significant hit on your lifestyle when you're no longer working, and thus unable to make up the difference from elsewhere.

Other issues with trading down

In some areas, those figures may be optimistic. The Wall Street Journal addressed this issue in June 2010, and observed:

The housing crash has pounded the higher end of the market, to which many 50- and 60-somethings have graduated. That has narrowed the price gaps between the upper and middle markets, meaning smaller homes aren't always much cheaper.

The Journal identified another problem. During the boom years, many homeowners took significant proportions of their equity out of their homes in cash-out refinancings. Those who were relying on rapidly rising property prices to replace in time for their retirement the money they spent may now be facing serious issues.

And there's yet another problem with downsizing a home: the cost. One real estate agent told the newspaper that transaction costs can amount to 10 percent when you buy and sell at the same time. Add to that the moving van, new carpets and curtains, and any possible capital gains tax liability, and the amount realized can turn out to be well below what was expected. Those contemplating trading down should do some serious math--and possibly take professional advice--before going ahead.

Current mortgage rates help some

Oddly, the quarter of pre-retirees identified by the SOA who managed to come up with a retirement plan that included retaining a mortgage may be better off that those who intended to be mortgage-free. That's because, as data from the Mortgage Bankers Association confirms, current mortgage rates are still exceptionally low, and the simple process of refinancing could boost their disposable income figures above what they were expecting.

Reverse mortgage an option?

Many financial advisers say that a reverse mortgage should be seen as a last option, and considered only by those who are facing serious money problems. That may be a little extreme, but anyone considering signing up for one should certainly make sure they understand all the implications before going ahead. The National Council on Aging has produced a free 28-page booklet, "Use Your Home to Stay at Home™", which is downloadable as a PDF, and which is a great place to start the learning process.

As a rule of thumb, those who are able to tighten their belts, and ride out the current market before trading down when prices are rising again, are likely to be better off doing so. Those with more urgent problems may benefit from a reverse mortgage.

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