Reverse Mortgage Prosperity The Power of the Reverse Mortgage By: Andreas Keller Published: 2014 As baby boomers face retirement, television ads are becoming daily reminders that equity in our homes is an untapped resource that can be unlocked with a reverse mortgage, also called Home Equity Conversion Mortgage or HECM, a government secured FHA loan. This mortgage empowers seniors aged 62 or older to withdraw cash tax-free from their homes while retaining the right to live in their homes indefinitely without having to pay monthly mortgage payments. These loan proceeds can be used for any purpose and borrowers are not required to pay back the loan until they sell the home or permanently move out of the home. Borrowers or their heirs are not personally liable for the loan as the lenders only security is the home. However, the media tends to caution seniors about reverse mortgages and most financial advisors or retirement planners have ignored them. This trend may continue until the reverse mortgage is proactively presented for what it truly is: An integral part of a retirement plan that helps retirees to close the gap between longevity and financial resources. The Best Engineered Financial Tool of Our Generation Jack Guttentag, Professor Emeritus at the Wharton School of Finance of the PennsylvaniaUniversity, aka The Mortgage Professor, stated that the Home Equity Conversion Mortgage is the best engineered financial tool of our generation and this article sets out to introduce this versatile retirement tool. Eligibility requirements for a reverse mortgage are minimal as there presently are no income, asset or credit requirements to qualify. These minimal requirements are due to the fact that borrowers are not required to make monthly principal and interest payments and only the house secures the eventual repayment of the accrued balance of the reverse mortgage loan. Although easy to qualify, the reverse mortgage is a multifaceted and flexible but complex financial tool, which demands access to high quality information and advice to optimally structure a retiree s future borrowing power for a time when it is needed most.
Today s growing senior population has a more accepting view of mortgages as a practical tool to be employed in financial planning. As such, the HECM s best feature, the growing line of credit, will become more important given its various options for withdrawing cash: 1. Monthly Payout: Seniors can opt to receive regular monthly cash advances, called tenure payments, for as long as they live in the home. This feature continues until the last surviving borrower dies and is a good choice for borrowers who need additional monthly income to cover daily living expenses. Alternatively, borrowers can choose a term payment for a specified period. This payout option should be used very carefully as seniors could run out of money when the line of credit is exhausted. 2. Line of Credit: Borrowers have the option of setting up a line of credit (a cash account ) and drawing funds whenever they wish. The unused line of credit, however, will grow over time and increase seniors future borrowing power, offering peace of mind in knowing that they can handle emergencies or unexpected needs. To enjoy the full benefit of the growing line of credit seniors should put it in place as soon as they reach the qualifying age of 62. With a line of credit interest accrues only on money used and there is no prepayment penalty. 3. Lump Sum: Borrowers may choose to withdraw cash immediately. They can take any portion or all of the funds available to them as Upfront Cash. This option is often used to pay off current debt, which increases the borrower s monthly spending money by the amount of the monthly payments that have now been extinguished. 4. Program Modifications: Under the HECM program borrowers have the option to switch between different options for a fee of $20 at any time. These modification options are not well known, but are very powerful because they offer flexibility if the borrower s circumstances change. There are three product options a borrower can choose from: 1. HECM Standard Program: The HECM Standard loan is the traditional reverse mortgage and is the most often used. This loan allows for more borrowing but at higher fees and costs.
The HECM Standard is mostly used by seniors who expect to remain in their homes and want to extract as much as possible of the available equity. 2. HECM Saver Program: The HECM Saver is designed for homeowners who want to borrow a smaller amount and pay lower fees and costs. The HECM Saver is for borrowers with short time horizons who want to minimize the loss of equity in their homes. The HECM Saver is ideal for people who plan to sell their home in a year or two and pay off the accrued balance of the reverse mortgage with proceeds from the sale of the home. Financial advisors are starting to realize that having their clients borrow from an HECM Saver is a good way to ensure that their clients do not run out of money during times when their investment portfolio is off. Using the line of credit offered by HECM Saver enables their clients to hold their investments in a bear market and stay on the path to a successful retirement. 3. HECM for Purchase Program: This loan allows borrowers to use the HECM reverse mortgage to purchase a new principal residence and not have to make any mortgage payments. This program is most often used by seniors who are downsizing and want to retain as much cash as possible or do not want to withdraw from their investment portfolios for the entire purchase amount of the new home. All HECMs offer fixed-rate or adjustable rate options. The fixed rate HECMs require full cash out at closing, however, and may soon be modified. Most likely the fixed-rate full cash out option may be restricted or suspended. (On Jan. 30, 2013 FHA announced that the Fixed Rate Standard HECM will no longer be available as of April 1, 2013. This change does not have a material effect for seniors who decide to age in their homes.) For borrowers who want to age in their homes and do not plan on leaving the home for their children or estate to inherit, the interest rate is irrelevant because neither the borrowers nor the heirs or estate are required to pay back the loan. If, however, a borrower wants to leave the house for his or her heirs, the reverse mortgage should not be used because the death of the last surviving borrower is an uncertain maturity event, which simply means that the longer the borrower lives the higher the debt and the lower the equity. By the time a borrower reaches the age of 100, all of the equity in the house likely will have been consumed by the increasing debt. A senior s borrowing power depends on three factors: property value, age of the youngest borrower, and the prevailing interest rate. Under the Standard HECM program: A 62-year-old borrower with a home valued at $500,000 would receive today a reverse mortgage loan of $312,500 or a monthly advance of $1,591.
A 72-year-old borrower with a home valued at $500,000 would receive today a reverse mortgage loan of $340,000 or a monthly advance of $1,951. An 82-year-old borrower with a home valued at $500,000 would receive today a reverse mortgage loan of $367,500 or a monthly advance of $2,678. A 92-year-old borrower with a home valued at $500,000 would receive today a reverse mortgage loan of $388,000 or a monthly advance of $5,354. These numbers show clearly the actuarial principle behind the reverse mortgage. The older the borrower, the more cash can be extracted from the equity of the home. Based on this principle, many seniors decide to wait to take out a line of credit, believing that they can get more money by waiting. Nothing is further from the truth. The Growing Line of Credit For seniors who take out a line of credit at the earliest eligibility age and possess sufficient discipline not to use it for impulse purchases, the rewards are substantial since the unused line of credit will grow at the interest rate on the mortgage plus the FHA s 1.25 percent annual mortgage insurance premium. Based on today s low interest rates, the line of credit will grow at an expected interest rate of 4.17 percent and will accelerate with any increase in interest rates. The unused line of credit has just turned into an investment vehicle with a rate of return that is superior to what today s market offers to savers. Age Growth Rate Line of Credit 62 4.17% $291,000 72 4.17% $500,000 82 4.17% $858,000 92 4.17% $1,400,00 99 4.17% $2,152,000 Year by year a senior s borrowing capacity and retirement wealth increases even if housing values should decline. As long as borrowers live in their home, pay property taxes and
homeowner s insurance and maintain their property in accordance with FHA standards, the line of credit cannot be cancelled or called by the lender. Financial planning professionals are beginning to take note as the HECM reverse mortgage emerges as an ideal complement to the challenging task of managing investment portfolios to yield a steady income stream for retirees. Cash Flow Survival for Retirees Financial planners are quite aware of the difficulty many seniors will face in retirement. Many simply will not have the needed funds. Others find it difficult to stay within withdrawal guidelines of taking out a mere 4 percent a year of the initial value of their retirement portfolio. And just about everyone will be affected by the rising cost of living. Therefore, the challenge for financial planners becomes how to protect their clients from the risk of running out of money in later years. Stephen Sacks and Barry Sacks, an economics professor and a practicing tax attorney specializing in pension-related legal matters, published Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income in the Journal of Financial Planning, in which they illustrate two strategies that favor the lifetime cash flow survival of the retirement portfolio: Funding retirement with a reverse mortgage first Starting retirement funding with annual withdrawals under a line of credit from a reverse mortgage allows the investment portfolio to keep on growing. When the line of credit is exhausted withdrawals come from the investment portfolio. The benefits of this simple strategy are that when withdrawals from the investment portfolio begin, they are smaller percentage-wise than the initial withdrawal amounts would have been at the outset of retirement. Together with the retiree s shorter life expectancy, the portfolio s cash flow survival improves substantially. Coordinating investment performance with the line of credit from a reverse mortgage With this strategy the investment performance of the retiree s portfolio determines the usage of the reverse mortgage line of credit. When the investment portfolio does well, the retiree withdraws money from it for the coming year; if the investment portfolio performs negatively, the retiree draws money from the line of credit. This strategy prevents the investment portfolio from being drained, supports any subsequent recovery, and protects the cash flow survival of the investment portfolio.
Exhausting the line of credit of a reverse mortgage first or coordinating the line of credit with the investment portfolio performance provides a high probability to close the gap between longevity and financial resources. More and more positive news about the reverse mortgage as a retirement tool is being published in financial publications everywhere, which encourages the cooperation and coordination of reverse mortgage originators and financial planning professionals to answer a common question of baby boomers: How do I avoid running out of money in retirement? The reverse mortgage no longer is seen as a last resort, suitable only for the cash-poor and house-rich, but instead is seen by more and more financial planners and advisors as a creative way of using home equity to its greatest advantage. In another study published by two professors from TexasUniversity, Dr. John Salter and Harold Evensky, they write: The main conclusion of this study is that HECM Saver reverse mortgages do have a place in mainstream retirement distribution planning, and have a significant impact on the probability that some clients will be able to meet their predetermined retirement goals.