Using HECMs to Increase Social Security Benefits?

January 6th, 2012 | by Jim Veale Published in News, Reverse Mortgage | 12 Comments

“You’d better not die” was a friend’s response after reading this article.

A major lender is “… pitching … the idea … to use the [adjustable rate Saver] credit line to help meet living expenses in the early years of retirement in order to delay filing for Social Security benefits as long as possible, thereby increasing monthly payments later and enhancing income in advanced age,” or so Mr. Mark Miller alleges in a December 8 article at Registeredrep.com.

Is this generally sound financial advice or a suitable use of HECM proceeds?

Significant Methodology and Assumptions

Examples will be used to demonstrate the strategy. So the examples can be presented as quickly as possible only minimal assumptions are presented in this section. To avoid a distorted, incomplete, or incorrect impression, reading the assumptions following the examples is highly recommended.

Because there are many unknowns, this evaluation does not consider 1) Congressional increases inSocial Security benefits, 2) investment opportunities with excess cash, 3) income tax implications, 4) extenuating circumstances, and 5) other factors. In essence examples will be looked at as if in a vacuum.

It is assumed that the weighted average effective note interest rate is 4% in all examples. Except as otherwise noted, the total costs financed will be assumed to be $2,000. Obviously the greater those costs are, the worse the results will be from using the strategy.

The borrower in the examples is a widow whose Social Security benefit at full retirement age of 66 is $2,000 per month; her monthly benefit at 62 will be $1,500 and $2,640 at 70. The monthly benefit will only be $2,480 at 69. The borrower is assumed to be fully retired the month before becoming 62 with no earned income for Social Security or Self-Employment tax purposes thereafter.

The first two months of tenure payments will all be received thirty-one days after the widow turns 62.

Here are four examples.

Examples

Example 1—Based on the information above, if the borrower takes $1,500 in tenure payouts for the full eight years until reaching age 70, the balance due on the AR HECM will be $182,279. If the borrower uses the amount of Social Security benefits in excess of $1,500 (or $1,140) to pay down the AR Saver each month after reaching age 70, it will take about 273 months or about 23 years to pay it off. So if the borrower dies before reaching age 93, the borrower would have been better off just taking $1,500 per month of Social Security from age 62 forward.

Example 2—Using the same information as in Example 1 but increasing total upfront costs financed to $9,000, the AR Saver balance due is $192,877 at age 70. The repayment period jumps up from just under 23 years to over 25 and one-half years. As expected this scenario is worse.

Example 3—This example is the same as Example 1 except the borrower has decided to work until age 66 and will not need any Social Security benefits until reaching that age. Because of her higher earnings she will be required to return all of his Social Security benefits between ages 62 and full retirement at 66 so she decides to delay AR Saver origination until reaching age 66. She wants to take the equivalent of full retirement age benefits upon turning 66 or $2,000 per month in tenure payouts. At age 70 she will take her full $2,640 per month benefits.

When the widow reaches age 70 her AR Saver balance due is $109,498. Using the $640 amount above the $2,000 she receives to repay the HECM, it will take her 313 months or just over 26 years to do that. So if she dies before reaching age 96, the use of the HECM was not economically sound. If she dies after reaching 96, it may have been a good idea, but was it worth the risk?

Example 4—Using the same information as Example 3, the widow has decided to wait until 69 to start taking her benefits. Since the benefits will only be $2,480 per month, she will only have $480 per month to pay down her Saver. Since she will only be receiving the $2,000 per month in Saver payouts for 36 months, her balance due at age 69 is only $80,477. At a repayment rate of $480 per month, it will take 25 years to pay off the HECM. Thus if the widow dies after age 66 but before age 94, will the additional benefits be worth the risk?

Conclusion

There appears to be few instances where this strategy helps. To show some benefit, one would have to come up with some very unusual fact patterns. Could we dream some up? Most likely but demonstrating when it could work is something those who actually promote this idea should present. If Mr. Miller is right, we would like to know why the strategy is being generally recommended.

Even if the borrower receives much less in tenure payouts than $1,500 at age 62, the borrower is missing out on the Social Security benefits which will not be made up at death, i.e. there is only a meager Social Security death benefit. Social Security benefits payouts not received due to failure to elect the benefit start date are not vested and thus are generally not recoverable. So in essence, the borrower is depriving her estate of those benefits and any earnings from the investment of the related cash until the difference in the higher Social Security benefits exceed the lost Social Security benefits plus lost earnings.

Some believe that the estate could be protected by life insurance. The trouble with that theory is the cost of the strategy would rise as well.

While deferring vested defined contribution plan (such as a profit sharing plan, 401(k), money purchase plan, and targeted benefits plan) distributions can be beneficial since they are vested, the same cannot be said for Social Security benefits which are not. In some ways delaying Social Security benefits can be riskier than seniors investing in deferred annuities with their HECM proceeds. As the old saying goes: “It all depends.”

To those who support the strategy, your comments are greatly appreciated. This forum is a place to exchange ideas on topics, not attack the promoters of ideas which may be in dispute. Different views are welcome.

Further Assumptions and Other Information

In presenting an evaluation of a financial strategy the evaluator should provide the assumptions used,the facts and circumstances considered, and other relevant, significant factors utilized. The goal of the examples was not to find situations when the strategy might work but rather to demonstrate how strategy is generally flawed. Thus unless the promoters can reasonably justify how the borrower or the circumstances of the borrower are sufficiently different to warrant the strategy, the promoter could be advising the strategy at the financial peril of the prospective borrower. Lenders and originators should take particular care in recommending the strategy in states like California where the fiduciary standard of care generally applies to NMLS licensees.

The only HECM used in the examples was the AR Saver since that is the product presented in the article by Mr. Miller. If the strategy is valid, the AR Saver definitely seems to be the preferred product unless other needs exist or the value of the home is insufficient to support the strategy.

The weighted average effective note interest rate of 4% seems reasonable based on the estimated length of the loan in the examples. If the actual rate turns out to be higher, the potential harm to the borrower from using the strategy could be greater and vice versa.

The borrower was assumed to have moderate wealth but is concerned about outliving her resources.Over the last twenty years she has worked with her financial planner so that she could live up to her expectations in retirement as long as she obtains her monthly Social Security benefit (or the cash equivalent) at age 62. The widow would also like to maximize her estate to the extent she does not need to maintain her retirement objectives. Her retirement financial plan becomes fully operational when she turns 62 and will not change except to adopt the replacing strategy promoted by the HECM lender starting on the day she turns 62.

The examples were based on the simple principle that cash can replace cash. So whatever the SocialSecurity benefit is at 62 will be replaced by AR Saver tenure payments of an equal amount.

Upon reaching age 70, the tenure payments will cease. Because the borrower cannot invest her money at a rate which will generate more income after tax than 5.25%, she will pay down her HECM starting at the time she actually receives her first Social Security benefit and the amount of the payment will be the difference between her actual benefit and the benefit she would have received if she started taking her benefit at 62.

Normally the reduction for starting Social Security benefit payouts before reaching full retirement age is 0.555% for each month such benefits start before reaching that age; however, the maximum reduction is limited to 25%. The monthly benefits at age 62 will be assumed to be $1,500 per month (or 75% of$2,000, the benefit at full retirement age of 66). Following full retirement age, any delay will increase the benefit 8% per year without compounding until reaching age 70; thus the monthly benefits at age 70 will be 132% times the monthly benefit at full retirement age. In this case she will receive $2,640 monthly starting at 70 if she delays taking any benefits until reaching 70. That is $1,140 higher than the benefit would have been at age 62, ignoring and excluding all congressionally granted cost of living adjustments (COLA).

James E. Veale, is a CPA, MBT and is a Senior Vice President at Security One Lending, Inc.

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Anonymous

In preparing for this article three weeks ago, I started a discussion on this topic on the Mainstreaming Reverse Mortgages Group over at Linked In. It was interesting that not one person condemned the strategy even though one thought it was a good idea. Another CPA said there was insufficient information.

Selling reverse mortgages advocating a strategy that is generally flawed can set our industry back rather than moving it forward. Back when Social Security benefits could be returned to the government to receive higher benefits, using HECM proceeds to take advantage of that strategy could make more sense but since the significant cutback as to when and how many monthly benefits can be repaid, this strategy is far less beneficial and more questionable than it once was.
Anonymous

Why does there have to be any repayment? The whole point of HECM is that no payments are required.
Anonymous

aliasBob,

Are you saying that you promote what it is Mr. Matt Miller describes? Please do not blame me for exposing the fact that the strategy is being promoted by some in our industry. You have Mr. Matt Miller to thank for that.

The article is not the official position of Security One Lending or RMD. It is the official position of its author and its author alone. It was vetted by several originators including two who are financial planners. It was written from a case study approach. If it has holes, you are specifically invited to destroy it. The problem with your comment is it adds nothing to the argument that the strategy can be employed to the financial benefit of the user and instead, further calls it into question.

Your defense reminds one of the tailors in the fable of the king who wore no clothes. It seems you want us to believe that the strategy is based on sound financial principles yet you do not provide them. The more you protest in that fashion, the more it appears your protestation is groundless.

I am fundamentally a CPA. Over the years as a member of several firms, I have been engaged to vet many financial plans. Some were sound for the client; some were not. Without a very special set of facts and circumstances, how does the strategy you espouse benefit the senior described in the article unless that individual lives into her very late 80s or early 90s?

Unless there are fundamentally sound financial grounds presented for the strategy Mr. Matt Miller describes, then why not have it condemned by NRMLA, FHA, and other industry setting standard authorities? Who wants our industry painted with the brush of promoting unsound strategies for the sake of making commissions? This is not the only strategy I condemn.

HECMs are loans of last resort PLUS a lot more. I support and promote many uses of HECMs including as a cash management tool such as that promoted by Mr. Harold Evensky, CFP and Dr. John Salter, CFP. They can also be employed in a proactive and aggressive manner to improve the cash flow of borrowers in later years by early acquisition and utilizing a specific tenure growth and multiplication strategy. Reverse mortgages have tax planning aspects which are employed today by a few but are also being greatly underemployed based on their potential. Today we are barely scratching the surface of how reverse mortgages can be employed in sound financial planning strategies. The problem is the one you espouse seems generally unsound but it is not by itself.

I also do not believe every senior needs reverse mortgage but I do believe many seniors who do not have one, should. Certainly every senior should know about reverse mortgages whether they currently have a home or not.
Anonymous

wicklar219,

There is a due and payable clause on all reverse mortgage notes I have read. Perhaps you have found one where no repayment is required. If so, I will originate for that firm as will all of my peers.

With an adjustable rate HECM, if the investment rate (on low risk liquid asset funds on an after tax basis) for excess cash is less than the net after tax cost rate of the HECM, why not pay down the HECM? As the old financial principle states: It is not what you make; it is what you keep that matters.

If the adjustable rate HECM borrower needs the cash out later, she/he can generally get all or any of it later unless the loan has been terminated because it was incorrectly paid in full (or suspended in rare situations where bankruptcy has been filed but not completed). That is what the cash management benefits of adjustable rate HECMs are all about. Please look at the strategy now being promoted by Mr. Harold Evensky, CFP and Dr. John Salter, CFP.

Clearly this strategy should be very cautiously employed by those with a fixed rate HECM. Without access to the line of credit, it is a very, very questionable strategy. In retirement, ready access to cash more than ever should generally be considered king!!
Anonymous

wealthone,

Repayment on an adjustable rate HECM is an excellent strategy when there is excess cash and the after tax rate of liquid investments is less than the after tax cost rate of the adjustable rate HECM. The pay down strategy also clarifies why the strategy in question is not suitable for many, if not the vast majority of, the senior home owning and HECM eligible population who are between 62 years old and 70 and have not elected the start date for their Social Security benefits. You seem focused on the financially less affluent and for some of them this strategy might make sense. The article does not rule out that possibility but it does ask its detractors to explain when the strategy described by Mr. Mark Miller is appropriate which you fail to do.

Do you really believe that the majority of those who will employ this strategy will be in the same homes until death? Remember when these folks start employing this strategy they are generally less than 66 years old. Estate planning is not just about after death planning; such planning also encompasses how clients will live in order to meet their at-and-after death goals. An estate is what an individual owns and owes. Estates like home equity are not static; estates generally do not become fixed until death.

Why would a senior not take Social Security benefits upfront and supplement Social Security benefits through HECM payouts later down the road? What you propose is reducing access to cash by substituting Social Security payouts with HECM payouts. Does that make sense? If the senior will move out of the home, planning for that circumstance may demand a HECM now to acquire the assets that will provide for the future cash flow stream when it is needed. If one strategy proves to produce the best risk tolerant answer, then that is the one which should be selected.

Using my own name, I fully condemn the general promotion of financial strategies which do not look at all aspects of the senior rather than some limited financial aspects. You condemn others for using pen names but you are throwing stones at your own glass house. You, guys, fight among yourselves and it is hilarious some of you complain about not knowing who the other person is. That in some of our eyes has as much logic as the validity of the general application of the financial strategy in question.

I challenge you to make it clear what some of the multiple benefits from employing this strategy might be. Are they all at the expense of the estate of the senior?
Anonymous

I don’t think he meant ANY repayment at all, but monthly or yearly repayment.
Anonymous

I am a reverse mortgage counselor. I know every HECM has to be repaid, but the point I was trying to make is that no payments are required as long as there is a borrower living in the property.

Most of the people I counsel only get Social Security to live on and they would be lucky to get $1,500 a month. There is no way they would be able to make a monthly payment on this loan. The majority of my clients need the reverse mortgage to pay off their forward mortgage because its 50% or more of their monthly income. Taxes in NY state are high so getting rid of their mortgage payment usually only results in 60% savings on their monthly payment anyways, but its better than nothing.

I would agree that this doesn’t seem like a good idea, but my reasons are different than yours.

Wendy
Anonymous

wealthone,

No doubt you are correct but I am no mind reader and had no idea who wrote the comment when I responded. I can only respond to what is written, right or wrong.
Anonymous

Wendy,

I disagree. They are exactly the same. I addressed suitability in a more affluent setting and you, in a less affluent situation.

To me few if any less affluent seniors should consider the strategy in question because it uses available cash. Looking at the senior as a whole, your concept is right. Delaying Social Security benefits by using up the line of credit of the less affluent looks like a poor decision on the surface unless there are unusual facts and circumstances.

With the Evensky/Salter approach, the goal is to never have an oustanding balance due on the HECM for any significant period of time. Their audience is more affluent seniors who they recommend replacing emergency cash funds with Saver credit lines and use the freed up cash for risk tolerant, diversified investment purposes which will yield greater wealth.

As a counselor, you provide financial risk assessment to both the less fortunate and Saver candidates with more affluence. So what would you advise the woman in the article?
Anonymous

Mr. Lunde,

I actually appreciate others reviewing my calculations. Rarely did things leave our office without reviewing the numbers. I expect review notes, just not many of them.

I have long promoted looking at the pay back benefit strategy until the recent change. If the client had a low risk tolerance or had a short expected life span, recommending the strategy verged on malpractice, although the concept would be discussed when initiated by such clients.

Before making any recommendations, I would always insist on looking at the numbers in the context of the goals and other financial strategies the senior was employing.

Thank you for your kind remarks.
Anonymous

big_d62

You state that most retirees you talk to “are afraid of running out of money” and that by adopting the strategy in question “the chances of their outliving their assets will be greatly reduced.” So what is it they are trying to achieve keeping their assets in tact or not running out of money? These are two different goals sometimes calling for two very different strategies. Maximizing Social Security is not a cure all.

For clarity sake, few seniors currently enjoying Social Security benefits will not technically run out of money. What they are really afraid of is running out of sufficient cash flow. If you ask those same retirees if they are afraid of Social Security cutbacks, most will also express fear of that happening. So here is what you are presenting: retirees are going to live off of loan proceeds to increase benefits from a government program which they generally fear will have severe cutbacks of those same benefits. The sheer irrationality of that strategy is not the issue; it is any financial strategy driven by fear.

You also bring up the issue of living off of loan proceeds rather than selling assets. Is that a good or bad idea? Many retirees are emotionally tied to some assets that are diminishing in value. Yet if logically presented to them, they would divest themselves of those same assets if it meant reducing the chance of “running out of money.” Some of the worst and most despicable financial strategies I have seen promoted are those which recommend that seniors allow their portfolios and retirement plans recover by reducing distributions and sales from those assets and living off of HECM or other debt proceeds without any caveat that those same assets be looked over to determine their suitability. Are those assets sufficiently diversified? Do they match the risk pattern which is appropriate for a person that age? Do the seniors even know what they hold? Are those assets diminishing in value and need to be liquidated?

I support sound, rational, suitable, and prudent strategies. I detest selling into fears. Ultimately all decisions should be made by the senior but such decisions should be as much as the senior can reasonably endure be informed decisions, not driven by fear.
Anonymous

I appreciate all of the comments in this thread and those have contacted me by other means. Thank you.

As a closing thought, the purpose of the article was not to suggest that the strategy in question should never be employed. It was a very negative reaction to the quotation from Mr. Mark Miller that a group of originators were “pitching … the idea.”

Social Security is now in play politically. What we deem a correct strategy today may prove to be entirely wrong in the coming years. Yet the strategy in question does not need negative changes to Social Security to be proven to have significant risk and be of questionable value.

The strategy in question can result in sound economic and financial results but only in the right circumstances. This is not a strategy which should be callously “pitched” to all.