Ask Bankrate: Are reverse mortgages risky? Is it smart to refinance one?

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Ask Bankrate is a recurring feature where Bankrate’s experts answer your financial questions. Visit this page for more information on how to submit your question. Click on a question here to jump straight to it.

Questions:

Q1: Are reverse mortgages risky for retirees?

What are the risks in reverse mortgages for those in retirement?

— Jerome C.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “I’m a fan of the reverse mortgage product because it will be a lifeline for millions of retirees in the years ahead. Far too many Americans are under-saved for emergencies and for retirement. Many seniors that have been in their homes for decades could have hundreds of thousands of dollars of home equity but do not have hundreds of thousands of dollars in their 401(k) or IRA.

There are a number of potential benefits to retirees of using a reverse mortgage. Start with paying off any existing mortgage on the home and eliminating the corresponding monthly payment — often the largest, or one of the largest, components of the household budget. That alone can stretch the life of otherwise modest retirement savings significantly because your monthly expenses are suddenly much lower. The ability to tap into a lump sum of equity to do needed repairs or modifications in order to age in place can be a game changer. Setting up a reverse mortgage to provide regular monthly payments can supplement existing retirement income and have a meaningful impact on a retiree’s lifestyle. Or just using the reverse mortgage to set up a line of credit that can be tapped for unplanned future expenses or in lieu of selling investments at depressed prices in years when financial markets have fallen. As with any financial product, shopping around among multiple lenders and consulting with your financial professional can help you avoid paying more in fees or signing on to less attractive terms. A lot of the ‘risks’ that are frequently portrayed in the media either have nothing to do with the reverse mortgage or are flat-out incorrect.

Here are examples of each:

  • The story of the homeowner that took out a reverse mortgage and ‘lost their home because the property taxes weren’t paid.’ Umm, that’s got nothing at all to do with the reverse mortgage. If any homeowner — with or without a mortgage — doesn’t pay their property taxes, they are subject to foreclosure by the taxing authority. Nonetheless, reverse mortgage regulations have been shored up to further assure that seniors either have those costs escrowed or have sufficient cash reserves to pay their property taxes and insurance.
  • A common, but very incorrect, statement made about reverse mortgages is that the homeowner has to give up the deed to their home. Nonsense. Just as you retained ownership of your home when you took out a traditional forward mortgage, you retain ownership just the same when taking out a reverse mortgage.”

Q2: Should you refinance a reverse mortgage?

Is it smart to refinance a reverse mortgage?

— Mario

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “Just as with refinancing a traditional forward mortgage, if the new rate is sufficiently lower than your current rate to make up for the closing costs, then yes it can be worthwhile. Since reverse mortgages don’t require monthly payments while the borrower still occupies the home, your motivation for refinancing a reverse mortgage may be different than those refinancing a traditional forward mortgage where reducing the monthly payments is the primary attraction. But given the costs involved, you may find that refinancing a reverse mortgage takes longer to recoup the costs than with a forward mortgage, or just isn’t worthwhile.”

Q3: I locked in a refinance rate. Can I still shop around?

If I lock in a rate with a lender for a refinance, am I required to use that rate or can I continue to shop around?

— Brandon H.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “You can shop around at other lenders, but if you pick a different ‘dance partner’ after the music has begun, you’ll start over in the mortgage application process. Also, any upfront costs you’ve paid with the original lender — application fee, appraisal fee or credit reports — would be lost. If you’re not yet on the hook for any costs and the loan process is dragging on, it might be cheaper to switch lenders (assuming you get a similar quote for rate and fees) than to pay for a rate lock extension.”

Q4: How should I invest in index funds within my Roth IRA?

How would you suggest investing with your Roth IRA concerning index funds for long-term holds?

— Kris R.

Answered by James Royal, senior investing and wealth management reporter: “The U.S. stock market is probably the best wealth-generating device ever created. So you want your money to remain invested as long as possible. A great option is a S&P 500 Index fund, which holds literally hundreds of America’s best companies in a single investment. You get broad diversification, and over time the index has gone up about 10 percent annually on average. It’s the investment that legendary investor Warren Buffett recommended to individual investors, and you’ll likely outperform more than 80 percent of investors in any given year and more than 90 percent over time, even the pros. A great practice is dollar cost averaging, adding a certain amount every two weeks or month, since it reduces the risks that you buy at a too high price. Happy investing!”

Q5: I have fewer than 35 earning years. How does that affect my Social Security?

I want to retire early, but due to having fewer than 35 earning years, how much will that impact my Social Security payments? I am in my 50s but have less than 35 years as I lived and worked overseas for a number of years, so Social Security was not taken out of my pay abroad. I’m estimating I have about 30 earning years. However, I recently read somewhere that someone who had done the calculations discovered at least for their situation that it only made about a $60 difference in their Social Security check. To me, that small amount is not worth extra years of working.

— Lee R.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “Go to the Social Security Administration website at SSA.gov and create a login. You’ll be able to review your annual benefits statement that used to come by mail every year, verify that your annual earnings are accurate, and see what your various benefit payouts will be if your earnings continued at the same rate up until you retire.

There is also a feature on the site designed to answer the very question you’re wondering, ‘what would my benefit be if I retired early/now?’ You can adjust the scenarios and play ‘what if’ for different ages, etc. In short, the years of zero earnings are factored in but with the 30 years of eligible earnings you have accumulated, you’ll likely find only a modest difference in monthly benefits by working five years longer. The real significant difference in benefits depends on when you claim — at age 62, at full retirement age, or each additional year you hold off up until age 70.”

Q6: When does it make sense to cash in a CD early?

My credit union has a 180-day interest penalty to cash in a 36-month CD before the maturity date. The current rate is 1.25 percent. When does it make sense to cash it in for a new, higher-rate CD? How high does the new rate have to be to make it worth the 180-day penalty?

— Richard G.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “It can make sense to cash in a low-yielding CD for a higher-yielding one if the amount of interest you’d earn on the higher rate CD is greater than the interest you’d earn in the remaining term of your original CD and the penalty you’d pay for the early withdrawal.

Let’s say you have one year left on your current CD at 1.25 percent and have $10,000 invested. Your six-month interest earnings penalty would be approximately $62.50 (assuming you had $10,000 invested over the past six months). You’d need to earn enough in the next year on your new CD to offset the $62.50 penalty plus the $125 in interest you were scheduled to earn. Taking the $9,937.50 you have left after the early withdrawal penalty and investing it such that you’d have $10,125 one year from now (what you would have had on the original CD) means earning an annual yield of 1.89 percent. And that’s just to break even, so you’d need a yield better than that to make it worth your while.

Long story short, with today’s low rates you are unlikely to find a high enough yield to justify the early withdrawal. Even top-yielding five-year CDs are paying little more than the 1.25 percent you’re currently earning.”