HECM Line of Credit

Research Review: Reverse Mortgages in Retirement Planning: November 12, 2015 Update

The research base on reverse mortgages in financial planning has significantly developed in the last three years. This post provides highlights of existing work. Noteworthy are results showing combining reverse mortgages with investment portfolio withdrawals to substantially improve sustainable retirement spending levels, and the benefits of getting a HECM line of credit early in retirement. If you know of other work, please let me know!

Research Overview:

Davison, Thomas C. B., and Turner, Keith. 2015. “The Reverse Mortgage: A Strategic Lifetime Income Planning Resource.” Journal of Retirement, 3(2): 61-79.

  • Comprehensive review and synthesis of personal financial planning research on applications of reverse mortgages to retirement income planning. Emphasis is on line of credit and its growth potential, and applying it along with other client resources like investment portfolios and social security. Major gains in lifetime spending can be seen with a variety of methods combining cash from reverse mortgage lines of credit and investment portfolios.
  • User demographics may be usefully sorted into those “well-funded” for retirement, with others “constrained” and “underfunded”. Typical uses will vary for different demographic groups.
  • A reverse mortgage line of credit can be usefully considered as an investment asset, with very low volatility, returns nearly those of equities, providing a high-return, low volatility asset.
  • Refinancing a traditional with reverse mortgage may have strong benefits, providing leverage as long as the client owns the home.

Reverse Mortgage Synergy with Investment Portfolios to Increase Cashflow

Several research teams have demonstrated substantial improvement in sustainable withdrawals when augmenting portfolio withdrawals with reverse mortgage draws in many different ways. This is due to several factors, including:

  • Portfolio returns are higher than housing returns: leverage works
  • More assets are available when housing wealth is included in spending
  • Reverse mortgage Lines of Credit are guaranteed to grow, potentially dramatically, over a homeowner’s lifetime
  • Sequence risk in early years is controlled when reverse mortgage funds are available early
  • Reverse mortgage draws are tax-free loan proceeds

Research from Wade Pfau, Gerald Wagner, and Barry & Stephen Sacks

A variety of strategies can be used to fund spending when combining reverse mortgage and portfolio draws.Wade Pfau analyzed 6 strategies, building on earlier work by Wagner and others. examines 5 strategies, such as a using the reverse mortgage line of credit first before any portfolio withdrawals, fixed monthly draws for 30 years, or monthly tenure advance guaranteed to continue as long as the homeowner stays in the house. All strategies improved sustainable retirement withdrawals. Benefits of each strategy are examined.

Pfau, Wade D. “Incorporating Home Equity into a Retirement Income Strategy.” Available at SSRN:  http://ssrn.com/abstract=2685816. November 3, 2015.

  • Abstract: “Strategic use of a reverse mortgage can improve retirement outcomes. The benefits are non-linear in nature, as they relate to the synergies created by reducing sequence risk for portfolio withdrawals and to the non-recourse aspects of reverse mortgages that can potentially allow a client to spend more than the value of their home. This article explores six different methods for incorporating home equity into a retirement income plan through the use of a reverse mortgage. Generally, strategies which spend the home equity more quickly increase the overall risk for the retirement plan. More upside potential is generated by delaying the need to take distributions from investments, but more downside risk is created because the home equity is used quickly without necessarily being compensated by sufficiently high market returns. Meanwhile, opening the line of credit and that 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. Use of tenure payments or one of the coordinated spending strategies can also be justified as providing a middle ground which balances the upside potential of using home equity first and the downside protection of using home equity last. A key theme is that there is great value for clients to open a reverse mortgage line of credit at the earliest possible age.”
  • See Robert Powell’s summary of this work: “How to use a reverse mortgage to protect your retirement income” at http://www.marketwatch.com/story/how-to-use-a-reverse-mortgage-to-protect-your-retirement-income-2015-11-11

Pfau, Wade. 2014. “The Hidden Value of a Reverse Mortgage Standby Line of Credit.” http://www.advisorperspectives.com Dec 9.

  • “In this article, I show that the benefits of opening a home-equity conversion mortgage (HECM) line of credit extend beyond meeting spending needs. With the current HECM rules, those living in their homes long enough could reap a large windfall when the line of credit exceeds the home’s value. This potential windfall is amplified by today’s low interest rates. Even if the value of the home declines, the line of credit will continue to grow without regard for the home’s subsequent value. Combining this with the fact that a HECM is a non-recourse loan means that the HECM provides a very valuable hedging property for home prices.”
  • The analysis suggests “suggest that the average 62-year old client will live long enough to have a 90% chance that the line of credit is worth more than their home. Any excess is the payoff from this strategy, and it also serves as a good protection from housing price declines.”
  • “The HECM program provides a way to create liquidity for the home, which is otherwise an illiquid asset. Removing the constraint about how home equity can be used affords a more efficient retirement-income strategy.Even if that line of credit does not end up being used to meet income needs, its growth could provide a way to leave a larger legacy at death. The HECM is non-recourse, and mortgage insurance premiums are paid so that the lender does not lose after having paid more to the borrower than the home is worth. In this sense, the mortgage insurance premiums can be viewed as insurance against a fall in home prices if one lives sufficiently long.”
  • http://www.advisorperspectives.com/newsletters14/Hidden_Value_of_Reverse_Mortgage_Standby_Line_of_Credit.php

Wagner, Gerald C. 2013. “The 6.0 Percent Rule.” Journal of Financial Planning, 26(12): 46 – 54.

  • With only the portfolio to fund spending, sustainable withdrawals were 3.75%. In contrast, “With a 30-year spending horizon and first-year withdrawal of 6.0 percent, reverse mortgage scheduled advances as a portfolio supplement give “spending success” levels of 88 to 92 percent. Even with a first-year withdrawal of 6.5 percent, success levels are still 83 to 86 percent.”
  • “This paper provides financial planners with a review of the relative merits of using a reverse mortgage as a retirement spending supplement.”
  • After 15 years, the client’s estate value is 10 to 30% higher using the reverse mortgage plus portfolio than relying on the portfolio alone, combining current portfolio, home value and deducting the reverse mortgage loan balance.
  • http://www.onefpa.org/journal/Pages/December-2013-The-6-0-Percent-Rule.aspx
  • Earlier version with additional commentary:
  • http://www.reversemortgagehomepage.com/Downloads/The_6PC_Rule.pdf

Sacks, Barry H., and Stephen R. Sacks. 2012. “Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income.” Journal of Financial Planning 25(2): 43-52.

Standby Reverse Mortgages: Improve Investment Portfolio Withdrawals by Borrowing From and Repaying HECM Line of Credit

A Standby Reverse Mortgage is a strategy of borrowing from the HECM Line of Credit when the portfolio has suffered a significant downturn and repaying it after the portfolio recovers, making it available to help future spending in the future. The team of Salter, Pfeiffer and Evensky introduced this concept.

Salter, John. 2015. “Is the Time Perfect to take Advantage of a Reverse Mortgage?” On this blog, and originally posted on http://www.nowitcounts.com  April 7

Pfeiffer, Shaun, C. Angus Schaal, and John Salter. 2014. “HECM Reverse Mortgages: Now or Last Resort?” Journal of Financial Planning 27(5) 44-51.

  • “This study outlines recent changes in the reverse mortgage market and investigates plan survival rates for distribution strategies that establish a Home Equity Conversion Mortgage (HECM) reverse mortgage line of credit at the beginning of retirement and as a last resort.”
  • “Early establishment of an HECM line of credit in the current low interest rate environment is shown to consistently provide higher 30-year survival rates than those shown for the last resort strategies. The early establishment survival advantage for real withdrawal rates at or above 5 percent is estimated to begin between 15 and 20 years after loan origination and is shown to be as high as 31 percentage points, or 85 percent, greater than the last resort survival rates.”
  • http://www.onefpa.org/journal/Pages/MAY14-HECM-Reverse-Mortgages-Now-or-Last-Resort.aspx

Pfeiffer, Shaun, John Salter, and Harold Evensky. 2013 “Increasing the Sustainable Withdrawal Rate Using the Standby Reverse Mortgage.” Journal of Financial Planning 26(12): 55-62.

  • Sustainable withdrawal rates jumped from 3.15% to 5 and 6% with a standby HECM Line of Credit.  The real key, not directly addressed in the article, is the size of the line of credit in relation to the portfolio. Clients had an important boost in sustainable spending with a line of credit as small as 8% – 10% of the portfolio. The authors note “The findings from this research suggest that the adage of using a reverse mortgage as a last resort could be a huge mistake in a rising interest rate environment where a retiree waits to set up a line of credit in the future.”
  • http://www.onefpa.org/journal/Pages/December-2013-Increasing-the-Sustainable-Withdrawal-Rate-Using-the-Standby-Reverse-Mortgage.aspx
  • Michael Kitces notes: “this latest version looks specifically at the maximum safe withdrawal rate that can be sustained by the strategy, and is updated for the latest reverse mortgage rules that took effect this fall. Using reduced market expectations (relative to historical standards), the results show a significant improvement in safe withdrawal rates (in the neighborhood of 5% even with lower return assumptions) under the standby reverse mortgage scenario, driven in part by the favorable liquidation effects and in part simply because the strategy taps home equity and introduces additional assets to the retirement balance sheet.” “clients who wish to implement the strategy should look at establishing the line of credit sooner rather than later (while interest rates are still low), even if there is no intention to borrow until an extended period into the future (to reduce the risk that rates will be higher and borrowing limits will be lower if the client waits until funds actually need to be used).”
  • http://www.kitces.com/blog/weekend-reading-for-financial-planners-dec-7-8/

Salter, John, Shaun Pfeiffer, and Harold Evensky. 2012. “Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions.” Journal of Financial Planning 25 (8): 40–48.

Salter, John, Shaun Pfeiffer, and Harold Evensky. 2012. “Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions.” Presentation sponsored by Genworth. Document created August 17, 2012.

  • Talk based on Journal of Financial Planning 2012 article. Additional charts of interest, including details of HECM balance usage. For example: Less than 25% of plans had a HECM loan balance in any year, and about 5% of months had a plan with 100% of line of credit used
  • http://bit.ly/1hgk0I2

Evensky, Harold. June 2013 “10 Questions. Harold Evensky on ETFs, Reverse Mortgages, and the Most Important Investment in the Coming Decade.” Journal of Financial Planning 26(6): 16-20.

Single Premium Immediate Annuities combined with Reverse Mortgages

Tomlinson, Joe. 2015. “New Research: Reverse Mortgages, SPIAs and Retirement Income.”  www.advisorperspectives.com April 14.

  • Single Premium Immediate Annuities (SPIAs) and reverse mortgage monthly tenure payments or Line of Credit withdrawals were combined to produce stable retirement income in combination with investment portfolio withdrawals. SPIAs and reverse mortgage monthly payments provide similar cashflow streams but also have important differences..Generally the reverse mortgage alone helped withdrawals more than a SPIA in the particular cases studied. Combining the two provided the best retirement income..
  • http://www.advisorperspectives.com/newsletters15/Reverse_Mortgages_SPIAs_and_Retirement_Income.php

Reverse Mortgages in Financial Planning – General

Guttentag, Jack posts as “The Mortgage Professor”

Johnson, David W., and Zamira S. Simkins. 2014. “Retirement Trends, Current Monetary Policy, and the Reverse Mortgage Market.” Journal of Financial Planning 27 (3): 52–59.

  • “This paper assesses the current and future challenges facing retirees, demonstrates how a reverse mortgage can be used to provide a supplemental source of retirement income, and explains the potential impacts current monetary policy and recent changes to the Home Equity Conversion Mortgage (HECM) program may have on the reverse mortgage market.”
  • Helpful section on how borrowers can receive proceeds. The article was done before changes later in 2014 including added protections for so-called “non-borrowing spouse” for those under 62 and generally increased initial loan amounts.

Kitces, Michael. 2014. “Taking a Fresh Look at Reverse Mortgages in Retirement.” AICPA Advanced Personal Financial Planning Conference.  January 21.

  • An updated version of earlier talks. Wide ranging while being detailed.

Kitces, Michael. 2013. “HECM Reverse Mortgages – Current Borrowing Limits May Not Last Much Longer.” Nerd’s Eye View. December 4.

Kitces, Michael. 2013. “Is a Reverse Mortgage Better Than Keeping a Traditional Amortizing Mortgage in Retirement?” Nerd’s Eye View. September 18.

Kitces, Michael. 2013. “Will New Reverse Mortgage Changes Make Them a Better Financial Planning Tool?” Nerd’s Eye View. September 11.

Kitces, Michael. 2013. “HUD Eliminating Fixed-Rate HECM Standard Reverse Mortgages, But HECM Saver Option Remains.” Nerd’s Eye View. February 27.

Kitces, Michael. 2011. “Evaluating Reverse Mortgage Strategies.” The Kitces Report. November.

  • Broad review of how reverse mortgages can fit in client’s retirement plans.

Kitces, Michael. 2011. “A Fresh Look at the Reverse Mortgage.” The Kitces Report. October.

  • Summarizes the internal workings of reverse mortgages.

Lynch, Nicholas C. and Charles R Pryor. 2012. “Know the costs, benefits and alternatives for this retirement funding tool.”  Journal of Accountancy. July.

Munnell, Alicia H. and Steven A. Sass. 2014. “The Government’s Redesigned Reverse Mortgage Program.” Center for Retirement Research at Boston College. January, Number 14-1.

  • Reverse mortgages, which allow retirees to tap their home equity, are insured by the government.
  • The financial crisis hurt both the government’s insurance fund and the borrowers: Declining home prices led to losses when homes were sold; More borrowers defaulted.
  • In response, the government has redesigned the program by: creating a single loan option with a lower limit and fees; limiting initial withdrawals; and requiring financial assessments of borrowers.
  • These changes should help reduce pressure on the insurance fund and make defaults less likely
  • Conclusion: “All these changes should be viewed as positive. A better customer experience combined with lower fees will also make reverse mortgages a more attractive option for retirees.”
  • http://crr.bc.edu/briefs/the-government%E2%80%99s-redesigned-reverse-mortgage-program

Sass, Steven, Alicia H. Munnell, and Andrew Eschtruth. 2014. A Retirement Planning Guide. Using Your House for Income in Retirement. Center for Retirement Research at Boston College. September.

  • “Using Your House reviews the two most common ways to use your house to boost your income in retirement – downsizing and a reverse mortgage – with clear examples, a discussion of the pros and cons of each approach, and links to tools on the web where you can get estimates of what downsizing or a reverse mortgage can do for you.”
  • http://crr.bc.edu/special-projects/books/using-your-house-for-income-in-retirement/

Quinn, Jane Bryant. 2013. “A great reverse mortgage idea: Take a credit line now.” August 15.

  • “But there’s a valuable new opportunity at hand, for borrowers who don’t need extra money now. You borrow as early as age 62 and take the mortgage in the form of a credit line instead of all-cash. You can borrow against the credit line at any time, but you don’t have to take the money now. More important, this credit line grows every year – greatly increasing your borrowing power in the future.”
  • http://janebryantquinn.com/2013/08/a-great-reverse-mortgage-idea-take-a-credit-line-now

Income Taxes and Reverse Mortgages

Blankenship, Vorris J. 2010. “The Taxation of Reverse Mortgages.” Journal of Financial Planning.

Davison, Tom. 2014. Income Tax Planning with a Reverse Mortgage.

Veale, James. Understanding the Tax Implications of a Reverse Mortgage (Part 1 of 2).

Veale, James. Understanding the Tax Implications of a Reverse Mortgage (Part 2 of 2).

U.S. Department of Housing and Urban Development

Home Equity Conversion Mortgages for Seniors

Technical Details for Reverse Mortgage Nerds

HUD handbook for Home Equity Conversion Mortgages (4235.1)

HUD Mortgagee Letters: Official HUD communications on Reverse Mortgages

HUD’s site for lenders: Home Equity Conversion Mortgages for Lenders (HECMs)

Need Help Finding References?

Send a note to tcbdavison@gmail.com for help finding a particular reference.

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