House rich and cash poor? High real estate values and the high cost of living have taken a toll on many here in the Santa Barbara area — and can have an especially big impact on seniors.

Let’s take the example of a couple now in their 70s who bought a home in the mid-1970s for about $50,000.

They worked hard, raised a family, saved what they could, paid off their mortgage, and retired at age 67 to get maximum Social Security benefits.

Fast forward to today with median home values around $2 million, and they seem rich. But savings went more quickly than expected over the first 10 years of retirement and living costs have increased about 40% over the decade due to inflation.

The couple is now facing serious cash flow problems. So, what to do?

• Sell the house. You could look for a lower-cost house and use the excess cash to meet living costs. But there can be strong resistance to moving, capital gain taxes and selling costs can be steep, and it might be hard to find a suitable “cheaper” house.

• Selling and renting. This would free up all net proceeds but, again, moving can be traumatic and a lot of work. And you have the taxes and selling costs, plus a tight rental market with some steep costs.

• Home equity line of credit. A HELOC loan could provide cash to meet living costs, but you have to qualify for the loan and would have to make loan payments back to the bank.

Or, what about a reverse mortgage? These loans let homeowners age 62-plus convert part of their home equity into cash without making monthly loan payments.

The loan is usually repaid when the homeowner sells the house, permanently moves out or dies.

The most common type in the United States is the federally insured Home Equity Conversion Mortgage, which is backed by the Federal Housing Administration.

Instead of paying it back each month like a regular mortgage, the lender pays you.

Here’s how it works:

• You can receive money as a lump sum, in monthly payments, as a line of credit, or some combination. Any existing mortgage would be paid off from reverse mortgage proceeds.
• You still own the house. You must pay property taxes and homeowners insurance, and you must keep the home in reasonable condition.

At least one borrower must be age 62 or above. There must be significant home equity, the home must be your primary residence, and you must show the ability to pay taxes and insurance.

And you must complete HUD-approved counseling for HECM loans. but this is truly for the borrower’s own protection. The amount you can borrow is determined by the age of the youngest borrower, home value, current interest rates and type of payout chosen.

Note: The older the borrower, the more money that can be borrowed.

Let’s look at how this might work for our Santa Barbara couple in their mid-70s with a home worth $2 million and no outstanding mortgage:

• Reverse mortgage type: FHA-insured HECM
• Loan amount: $670,000
• Combined annual cost (interest + FHA insurance): 7%
• Assumed home appreciation: 3% annually

Note: These figures are illustrative only. Actual results would depend on rates, draws, home values, etc.

Home appreciation matters enormously. If appreciation were weaker, flat or even declined, remaining equity would be much different.

And with many HECM reverse mortgages, an unused line of credit can itself grow over time as the home value increases. That can create a larger borrowing reserve later in retirement rather than immediately drawing the maximum as a lump sum.

Like most options, there are pros and cons to reverse mortgages. Negatives include high fees, complexity, equity erosion and the impact on heirs.

Reverse mortgages may not make good sense if the borrower doesn’t plan on staying in the home for a long time.

And costs typically include FHA mortgage insurance of about 2% of home value, $6,000 origination fees, $1,000 for appraisal, $2,000-$5,000 or more for title/escrow/settlement, $1,000 for recording/miscellaneous fees, and $250 for a HUD-required counseling session.

But, if you find yourself house rich and cash poor, a reverse mortgage may be worth looking into.

Click here for more information from the Housing and Urban Development Department.

And as with most important financial decisions, it would be prudent to seek the advice of legal, tax and financial professionals to understand the pros and cons of what makes sense for you.