Introducing the NEW reverse mortgage
by Shelley GiordanoMs. Giordano is Chair of the Funding Longevity Task Force and author, What’s the Deal with Reverse Mortgages? She is an advocate financial literacy with Women in Housing and Finance and is a member of the FPA and NAIFA. Connect with her by e-mail: [email protected]
What doRobert C. Merton, Nobel Laureate and MIT Professor ; Wade Pfau, Princeton PhD, CFA, Professor of Retirement Income at the American College; John Salter, PhD, CFP, Associate Professor Department of Personal Financial Planning at Texas Tech University; and Barry S. Sacks, MIT PhD, Harvard JD have in common?
One answer would be that they, like other academicians in a range of disciplines, are concerned that American Boomer retirees will fall woefully short in providing for themselves as they begin to draw against their defined contribution plans.
Among other issues, these respected researchers share a keen interest in the role of housing wealth in retirement. Specifically, they are encouraging the American consumer, and those who advise them on the distribution of their assets in retirement, to take a fresh look at reverse mortgages.
Linking reverse mortgages to respected names such as these may be shocking to some who know little more about reverse mortgages than what they see on TV. Unctuous celebrity pitchmen incessantly flogging easy money confirm for many that the reverse mortgage must be some kind of scam.
Front-page stories featuring seniors who face foreclosure, or a widow whose husband has died being forcibly displaced, are searing images not easy to square with legitimate financial practices. No wonder established American homeowners and those who advise them sniff “not for me.”
But advisers who ignore the changes made to reverse mortgage lending will fail to appreciate how the prudent use of housing wealth in the distribution phase can contribute to cash flow survival and even improve the overall bequest.
How the Reverse Mortgage Has Changed
An adviser should know that Congress and HUD-FHA have acted to rectify lending abuses. Beginning with the Reverse Mortgage Stabilization Act of 2013, consumers are forbidden to use too much equity too soon.
Enhanced protections are in place to protect the non-borrowing spouse so that he or she can remain in the house once the borrower dies. Homeowners either not inclined to, or incapable of, meeting ordinary home ownership responsibilities, such as taxes, insurance and maintenance, will not qualify for a reverse mortgage.
Therefore foreclosures based on tax and insurance failure is unlikely. The issue of upfront fees has been addressed both by competition on the secondary market and by the reduction of mortgage insurance premiums for clients using their home equity slowly.
Why Advisers Took a Second Look
In the past, a reverse mortgage was burdened with high set-up fees and set-asides. Now that these fees are dramatically reduced, advisers can focus on how this fairly priced product can serve as an additional asset in retirement.
A striking feature of this FHA-insured reverse mortgage known as the Home Equity Conversion Mortgage (with the inelegant acronym HECM) is its durability. Once in effect the loan is guaranteed to be in place until the last homeowner dies, moves or sells. The terms cannot be altered even if the underlying asset, the house, declines in value.
By now, most people should know from TV that the homeowner retains title to the home, just like with any other mortgage. Surprisingly, however, there lingers, even among advisers, the notion that the “bank gets the house.” Not only is this not true, but the homeowner, or his estate, is entitled to whatever remaining equity there is beyond the value of the house at loan’s end.
What particularly interests thinkers like Robert C. Merton is the non-recourse guarantee. Should the loan balance exceed fair market value of the house, neither the homeowner nor his estate would ever be held responsible for debt in excess of the house itself.
A Unique Feature
Once advisers understand basic HECM features that HECM pricing has improved and that consumer safeguards are in place, they are equipped to evaluate how the HECM Line of Credit option may contribute to retirement income security.
The HECM LOC is unlike any other lending vehicle; it is guaranteed to grow at a contractually determined rate month after month, year after year. Unlike credit card lending, the growth in borrowing power is not arbitrary.
The HECM LOC will expand at exactly the same rate as the loan balance is growing. This growth happens regardless of declining home values, or other market conditions. Starkly different than a Home Equity Line of Credit (HELOC) the HECM LOC cannot be canceled, frozen or reduced, even if there are drops in home value. If all available credit has not been accessed, the HECM LOC is perpetually growing at the cost of money, compounding in value throughout the life of the loan.
Pfau notes that the HECM LOC diversifies the housing asset. Housing value is dependent on what someone will pay for it when the homeowner wants to monetize it. The HECM LOC can actually diversify this risk because the LOC may provide funds in excess of the home value. The non-recourse feature protects the borrower and in effect, provides a hedge against declining property values.
In addition, the HECM LOC can behave as a revolving LOC. John Salter, PhD, CFP, along with Harold Evensky and Shaun Pfeiffer at Texas Tech, published a study demonstrating that significant cash flow efficiencies could be achieved if portfolio draws were suspended in poor markets, replaced with draws from the reverse mortgage, and then paid back once the portfolio returned to its expected glide path.
The Texas Tech team confirmed the seminal study by Barry S. Sacks and Stephen R. Sacks in 2012 that first examined how coordinating draws from the HECM with portfolio draws provided protection against sequence of returns risk and reverse dollar cost averaging, the evil twins of retirement security. These researchers demonstrated that net residual wealth, inclusive of home equity, was significantly improved by avoiding selling off assets in a bear market.
Additional Studies Confirming the Utility of Integrating Home Equity Into Retirement Income Plans
Not surprisingly, given the intractable problem many Boomers will face in making their retirement assets last, for what could be a very long retirement, more light bulbs are going off across the financial community.
A blog maintained by Thomas C.B. Davison, PhD, CFP , www.toolsforretirementplanning.com is perhaps the best source for a complete and current accounting of research on this subject, including his own papers and case studies. Actually, case studies are increasing in frequency as advisers deliberate on how housing wealth can work synergistically with other retirement assets. Besides setting up a HECM Line of Credit, there are other approaches that can improve the household balance sheet in retirement:
- 1. Monthly Payments (Supplemental Income)
a. Reduces draws on portfolio
b. Provides tax advantaged funds so that less is drawn from taxable accounts
c. Term payments can provide income bridge during Social Security deferral years
- 2. Lump Sum
a. Replaces traditional mortgage with reverse mortgage / no required monthly debt payments
b. Allows purchase of vacation home with no monthly obligation for P and I payments
c. Allows investment in encore career…no payments required, pay down when business profitable
- 3. HECM for Purchase
a. Allows for financing of new principal residence without mandatory debt obligation
- 4. Gray Divorce
a. Allows both spouses to acquire equivalent housing without debt obligation/portfolio draws
- 5. The Ultimate Interest Only Loan
a. No recast period
b. Payments voluntary/ make them only when convenient
c. Each payment results in dollar for dollar growth in Line of Credit
d. Can structure so that loan balance stays static and house pays back the principal
- 6. Tax Considerations
a. Link house to beneficiary of IRA/401K for tax deduction on mortgage interest
b. Structure draws to manage tax brackets
c. Pay Roth Conversion taxes
d. Reduce Medicare surcharges
- 7. Self Insure for Long-Term Care by Establishing Right to Access Bulging Credit in the Future
Advisers have been slow to grasp how reverse mortgage lending has changed. If the first impulse is to counsel clients to “wait” until the portfolio is depleted before establishing a HECM Line of Credit, the adviser is giving out-dated advice. Compliance officers who forbid conversations with clients on how a significant asset, the home, can improve retirement outcomes are not meeting appropriate standards of care.
And finally, the knee-jerk advice to just “downsize” often does meet the client’s needs and preferences to stay in a beloved home or community. By mastering the nuances of the newly structure HECM, and the innovative ways colleagues are using reverse mortgages, the more adept the adviser will be at providing expanded options for his practice.
Thank you to the Funding Longevity Task Force and James Warns of Richmond, Virginia.
2. Loan proceeds taken during the term of the loan are generally free of income tax; borrower should seek professional advice re possible tax implications at loan termination when loan balance exceeds home value.
3. John Salter, Ph.D., CFP®, AIFA®; Shaun Pfeiffer; and Harold Evensky, CFP®, AIF®
Standby Reverse Mortgages: A Risk Management Tool, Journal of Financial Planning, August 2014