Tuesday, August 23, 2016

Ten Strategies for Using a Reverse Mortgage to Help Fund Retirement

In my last post, The Mortgage is Dead; Long Live the (Reverse) Mortgage, I wrote about retirement researchers' renewed interest in an improved reverse mortgage product, the Home Equity Conversion Mortgage, or HECM. The post spawned a great conversation in the comments area that pointed out, among other things, just how complicated these products are. But, that complexity contributes to the HECM's versatility.

There is more than one way to use a HECM in retirement and there is more than one kind of HECM. HECMs can be fixed rate or variable rate and there are several ways the proceeds can be distributed. There is even a HECM program that makes it easier for seniors to buy a new home when they don't have adequate income to qualify for a conventional mortgage.

This post is a summary of strategies – not an exhaustive list, by the way – compiled from the books, research papers and blog posts referenced in the endnotes below, that retirees might use to incorporate a HECM into a retirement plan.

As I suggested in the series of posts beginning with A Model of Retirement Planning, Part 1, approaching a retirement plan from a strategic perspective has several advantages. In effect, strategic planning identifies and answers the larger problems first (What do I want to achieve? What do I want to protect? What do I want to leave to my heirs?) and only then considers the best tactics to achieve those objectives (Should I use a reverse mortgage, equities or an annuity?). Once you have identified your strategic goals, some of these HECM strategies might help you achieve them.

Refinance Strategy

Do you currently make a monthly mortgage payment to the bank and would prefer that they send you a check every month, instead? If this sounds like magic or the late-night rantings of Fred Thompson, it isn't. The difference is that a conventional mortgage is building the equity in your home while the reverse mortgage is essentially spending it. Retirees who want to pass their home without debt to heirs should go the conventional route, while those who are happier depleting some or all of the home's equity to pay bills will favor the reverse mortgage alternative.

Refinancing is probably the most common use of HECMs. A retiree can refinance an existing conventional mortgage with a HECM and exchange her monthly mortgage payments for monthly loan distribution checks to spend as she sees fit. This is a double win for a retiree who currently holds a conventional mortgage – consumption is increased by spending home equity while expenses are reduced by eliminating the conventional mortgage payments.

The downside of the reverse mortgage is that spending the equity will have an impact on heirs, though they will have the opportunity to pay off the HECM and keep the home by arranging their own mortgage if your estate cannot. This is the strategy discussed by reverse mortgage originator, Jim Dean, in the comments section following my previous post. It is also thoroughly covered in Shelley Giordano's book, What' the Deal with Reverse Mortgages? (available at Amazon, see link below).

Credit Line Growth Strategy

A unique feature of HECMs is that the line of credit automatically grows over time by roughly the loan's interest rate and it increases with the age of the younger borrower. The longer you wait to spend the proceeds after taking out the mortgage, the larger your line of credit will be when you do spend it. This feature can be used to increase borrowing by taking out the loan early in retirement and spending the money years later.

As retirement researcher, Wade Pfau points out in Incorporating Home Equity into a Retirement Income Strategy, “. . . opening the line of credit at the start of retirement and then delaying its use until the portfolio is depleted creates the most downside protection for the retirement income plan. This strategy allows the line of credit to grow longer, perhaps surpassing the home’s value before it is used, providing a bigger base to continue retirement spending after the portfolio is depleted.” This strategy can be combined with others to increase the amount that could be borrowed later in retirement, for example, to pay for long-term care.

Income Strategy of Last Resort

The most common use of home equity by retirees today is probably to support spending when resources run low at the end of retirement. This was the common wisdom prior to recent research. The new research, however, suggests that spending from the HECM early in retirement rather than as a last resort tends to lead to better outcomes. When the spending will occur later in retirement, the research suggests it’s better to lock in the HECM early and let the line of credit grow. This is especially true in today’s low-interest rate environment that will contribute to growth of the line of credit as rates rise. According to Pfau, “the strategy for using home equity as a last resort supports the smallest increase in success.”

Term and Tenure Strategy

Tenure payments are one of the options for HECMs. These are monthly payments issued to the borrower for as long as he or she lives in the home. They are similar to an annuity, except that annuities pay as long as the annuitants are still living.

Another major difference between tenure payments and an annuity is that the retiree may “leave money on the table” if she dies soon after purchasing an annuity. If that happens with a HECM, there will be no such loss because the borrower will simply have borrowed less of her home equity. With tenure payments, the borrowed amount may eventually exceed the value of the home, but the borrower will never need to repay more than the home's then-current value.

A paper by Gerald Wagner entitled, “The 6.0 Percent Rule”, explains the value of the term and tenure options of HECM loan disbursements in greater detail.

HECM for Home Purchase Strategy

After you retire, you may find it difficult to qualify for a loan no matter how high your credit score because you won't have adequate income. (Former Federal Reserve Chairman, Ben Bernanke, says he was once turned down when trying to refinance.) A HECM has less rigorous credit qualification because it is backed by the home that you already own and it might be the answer to your problem.

HECM for Home Purchase is an FHA program that allows seniors, age 62 or older, to purchase a new principal residence using loan proceeds from the reverse mortgage. The program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction and avoid double closing costs. The program was also designed “to enable senior homeowners to relocate to other geographical areas to be closer to family members or downsize to homes that meet their physical needs.”

According to Jack Guttentag, author of the Mortgage Professor's website, “Prior to the HECM for Purchase program, the senior who wanted to purchase a house but could not afford to pay all-cash had to take out a forward mortgage to buy the house, then repay it by drawing on a reverse mortgage. Because the senior had to qualify for the forward mortgage in the same way as any other home purchaser, insufficient income or poor credit could bar the way. Furthermore, the senior who did qualify had to pay settlement costs on both the forward mortgage and the HECM. The new HECM for purchase program eliminates these problems.”

The Mortgage Professor website provides a nice overview of the HECM for Purchase program (link below) and the alternatives a retiree should consider.

Emergency Backup Strategy

A HECM can be established to act as an emergency fund. As described above in the Credit Line Growth Strategy, it might be wise to secure the mortgage early in retirement to allow the credit limit to grow over time.

Long-Term Care Strategy

Some retirees who find long-term care insurance unaffordable or flawed plan to tap home equity to pay for those potential expenses. A HECM line of credit is a good way to achieve this. Again, securing the mortgage in early retirement will maximize the amount of credit available when needed.

Divorce Settlement Strategy

Divorce can have a huge impact on retirement security and the incidence of elder divorce is growing. To show the broad range of retirement strategies afforded by reverse mortgages, consider this possible strategy for providing equal housing after divorce suggested by Giordano.

“For clients who qualify, a reverse mortgage can provide two options that may restore desirable housing to both spouses. By providing financing without a monthly debt obligation, each former spouse can enjoy equal housing without necessarily requiring portfolio distributions. Retirement security is enhanced for both without downgrading the living situation for either”, says Giordano.

A HECM might allow the couple to split the equity of the existing home, which one former spouse can then own, while providing funding for the second spouse to make a down payment on another home. The second spouse might also then combine that down payment with a HECM for Purchase mortgage, enabling both former spouses to own their homes without making mortgage payments. This may be a much better solution than liquidating the original home so the assets can be evenly split.

Social Security Bridge Strategy

Retirees are repeatedly told that they can mitigate longevity risk by delaying their Social Security benefits claiming age. Most households, though, claim Social Security benefits at earlier ages, probably because they need the benefits right away. (The most popular age to claim benefits is the earliest, 62.)

HECMs should be considered as a possible source of funding to help bridge the gap while you delay those benefits. Tom Davison provides a case study of this strategy at his Tools for Retirement Planning blog (link below).

Davison's case study assumes that the retiree plans to live in the home throughout retirement, so it is worth a note of caution here. For strategies that spend from a HECM early in retirement, like this one, the borrower will need to repay the loan if she decides to change housing later in retirement. Retirees who believe they might not stay in the current home throughout retirement need to perform further analysis before deciding on the strategy.

HECM Stock Purchase Strategy

One dangerous strategy, used so often that FINRA felt the need to warn against it (see Betting the Ranch, below), involves obtaining a line of credit secured by the investor's home to buy stocks. If you must buy stocks on margin – and I generally recommend that you don't – pledge the equities as security, not your home. If the market crashes you will go broke faster, but you will lose your stocks and not your home.

(Update: I asked FINRA if their Betting the Ranch warning applied equally to HECMs and conventional mortgages and they referred me to a newer warning entitled Avoiding a Reversal of Fortune (link below) that addresses the issues specific to HECMs. Short answer: it does.)

What To Do

Given the wealth of strategies, how should you integrate a HECM into your retirement plan? Very carefully.

Most every reverse mortgage expert with whom I spoke mentioned that careful planning is needed to integrate a reverse mortgage into a retirement plan. Giordano pointed out that spending proceeds early in retirement cuts off some later options. Davison noted that just because the Social Security Bridge strategy can improve benefits doesn't mean that using the Credit Line Growth strategy and spending later in retirement won't be even better for some households, so multiple strategies should be compared.

I have a couple of concerns. First, this product is very complex. After two months of research, I have not mastered the subject. Second, as Giordano explains in her book's Chapter 13, How Do I Discuss This With My Financial Adviser?, advisers may not recommend them for various reasons even if they are in your best interests. Many advisers don’t understand them. Other advisers are not allowed by their compliance officers to offer them.

Your options are to find an adviser who does understand them and is willing to recommend them if they are the best solution for you, or to invest a lot of time understanding them yourself. Given the potential benefits, I think either path is worth the effort.


Ten strategies for using a reverse mortgage in retirement.
[Tweet this]


The Federal Government offers two major programs to assist with funding retirement: Social Security and the Home Equity Conversion Mortgage. These are especially helpful for retirees who weren't able to accumulate large retirement accounts.

There are many ways to employ a reverse mortgage in a retirement plan. Given that so many households have most of their wealth tied up in home equity, it is becoming urgent that we find ways to spend that equity. The new and improved HECM offers several opportunities.

There are some risks, however. I'll cover those in my next post, The Risks of Reverse Mortgages.

Special thanks to Shelley Giordano, Jim Dean and Tom Davison for their help with this post!



REFERENCES

What's the Deal with Reverse Mortgages? by Shelly Giordano, available at Amazon.


Tom Davison's Tools for Retirement Planning website extensively covers reverse mortgages.


The Home Equity Conversion Mortgages for Seniors portal at the HUD website


The Mortgage Professor website post on the HECM for Purchase program


HECM for Purchase program at the HUD website


A Model of Retirement Planning, Part 1 describes a strategic approach to retirement planning


The Mortgage is Dead; Long Live the (Reverse) Mortgage, the first post of this series on reverse mortgages


Incorporating Home Equity into a Retirement Income Strategy, research by Wade Pfau.


“The 6.0 Percent Rule.” (downloads PDF) demonstrates the value of term and tenure payments.


Betting the Ranch: Risking Your Home to Buy Securities, FINRA warning regarding investors obtaining lines of credit secured by their homes for the specific purpose of investing in securities. Replaced by HECM-specific Avoiding a Reversal of Fortune.


Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income, Sacks and Sacks (2012)


Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions, Salter, Pfeiffer, and Evensky (2012)


HECM Reverse Mortgages: Now or Last Resort?, Pfeiffer, Salter, and Evensky (2013)


AARP Reverse Mortgage Pamphlet (downloads PDF)


Why Ben Bernanke Can’t Refinance His Mortgage.


Gray divorce on the rise with longevity trend from InvestmentNews.com.


Reverse Mortgage Funds Social Security Delay, a case study by Tom Davison at the ToolsForRetirementPlanning.com blog.


8 comments:

  1. An excellent and concise post Dirk ... this one is bookmarked in my resource files on the topic. Well done!

    ReplyDelete
  2. I would suggest one more possible strategy. Use a line of credit reverse mortgage to pay taxes on converting a large Ira or 401k to a Roth IRA or Roth rollover Ira. Some strategizing may be necessary to minimize tax paid (perhaps spreading the process out over several years between retirement and age 70 1/2). But the end result would eliminate the rmd and tax problems after 70 1/2 without paying the conversion taxes out of pocket or worse yet from the proceeds of the ira or 401k

    ReplyDelete
    Replies
    1. Interesting idea, Mark, but I would need to give it a bit more thought. First, most of the new research suggests that the best strategies are those that open a HECM early in retirement and spend from it it late. This strategy spends the money up front.

      Second, as Shelley Giordano points out, spending the equity early in retirement cuts off options later in retirement.

      Your approach would make more sense if a retiree were fairly certain he would not move out of the home at some point.

      Lastly, borrowing against your home increases mortgage repayment risk. Sure, if a retiree is able to stay in his home for the rest of his life, the HECM won't need to be repaid until death, but there are scenarios in which the retiree might well need to move out and would have to repay the loan sooner than expected. Even if I were certain I would never want or need to move, I feel a little queasy about putting my home at risk with a mortgage to save money on taxes, especially when there might be more profitable strategies for that home equity.

      It is an interesting idea, though, and it deserves more thought than I have just given it.

      I think there are probably several more strategies one might use.

      Happy to discuss.

      Thanks for writing!

      Delete
  3. Good thoughts Dirk. I would advise opening hecm line of credit as early as possible and let the line expand until 67 or 68 (5 to 6 years) to hopefully provide a remaining cushion. I would suggest on your other point about the possible sale of the primary residence if one were to assume a long term rate of appreciation of 3% for real estate on average and you only used the amount of your initial hecm equal to or less than 1/3 the amount of your property value at time of issuance you would be able to sell your home pay off the existing hecm and then buy an equivalent value or less home elsewhere using a new hecm to purchase with the only exchange risk being transaction costs. Because you maintain a 3/1 ratio of initial home value to hecm amount because of inflation over time you should have a wash in regard to increase of hecm amount.

    ReplyDelete
    Replies
    1. Mark, 5 or 6 years of line of credit growth would miss out on the major benefits, given the compounding, of the 15 years or more of growth that you would enjoy with a late-spending strategy.

      If a retiree were to assume 3% real estate appreciation a lot of good things would happen, but that isn't a safe assumption. In some neighborhoods, house prices are falling. Robert Shilller tells us the long term after-inflation rate of appreciation for housing is about 0%. Were the last 30 years a "fad" or will housing return to it's growth heyday? If real estate does appreciate 3% annually on average, will your house be in the average? That's the bet you're proposing.

      As an aside, I think people feel worse about RMD's than they should. I agree that we should try to minimize taxes legally, but people who saved in IRA's got a tax break initially. As a result, their IRA balances are higher than they would have been otherwise. Figuring out a way to get another tax break on those savings is legitimate, but isn't that really icing on what was already a pretty nice cake?

      It still seems to me that strategies that spend late offer significantly greater benefits than those that spend early. I wish I felt more confident about 3% housing appreciation, but I don't, and I think their are more prudent strategies.

      I love the creative thinking, though!

      Cheers!

      Delete
  4. Dirk,

    Kudos for putting all of these strategies into one very readable place. I've been preaching these concepts for years and more and more financial advisers are finally seeing the light. Keep up the good work.

    ReplyDelete
  5. I'm honored that Reverse Mortgage Daily noticed my post and it offers me the opportunity to make an important point. Although their piece it entitled, "Financial Planner Lists Top-10 Reverse Mortgage Strategies to Fund Retirement", I would not characterize these as "the Top 10 Strategies". They're just 10 strategies.

    My point is that I didn't rank them. I can't really, because different strategies will have different values for different households. I can't even be sure that there isn't one out there that is even better than these – my list isn't exhaustive.

    Why is that important? For example, as Tom Davison recently told me, the Social Security strategy will be perfect for some households but other households may find even better uses for a reverse mortgage.

    My point is this. Once you find a good HECM strategy, keep looking to make sure there isn't an even better one.

    ReplyDelete
  6. Dirk, thanks for exploring and sharing strategies for using the reverse mortgage. I'd like to expand on a couple you include.

    For the refinancing strategy, while monthly mortgage payments are not required (borrowers still need to pay property taxes and insurance), one can make payments on their reverse mortgage. An example, they do the reverse mortgage, pay off their current mortgage, then continue making the payment on their reverse mortgage. The benefits are they are reducing the loan balance and with the adjustable rate reverse mortgage option, the funds paid go to their line of credit so they would become available for use again in the future if and when needed.

    Another benefit is they can choose if they make the payment and how much and when they make them. For example, they pay $1,000 toward the reverse mortgage but decide they want to take a vacation, or they have a medical expense, and can't afford to make the payment(s), there is no penalty because payments aren't required. With a conventional mortgage they would be facing foreclosure in just a few short months of non-payment; not so with the reverse mortgage.

    Another point I'd like to share is with the HECM for Purchase, one can purchase a new home that fits their needs better and may be even a higher value than the one they are selling. I recently worked with borrowers who needed to eliminate stairs for health reasons. They sold their current home for $225,000 and purchased a nicer, more fitting to their needs home for $370,000. We set it up so as an adjustable rate, didn't use all the sale proceeds for the purchase so they have funds available in a reverse mortgage line of credit and didn't have to touch their other retirement funds.

    Everyone's situation is different and the various options need to be considered to decide which fits their needs the best. Working with a financial planner and a reverse mortgage originator as a team benefits the borrower(s).

    Beth Paterson, CRMP
    NMLS #342859

    ReplyDelete