The historically low interest rates stemming from federal economic recovery efforts negatively affect seniors’ annuity investments, but the impact on reverse mortgages presents a silver lining, suggests research recently published by the Boston College Center for Retirement Research (CRR).
While more than half of today’s households will not have enough retirement income to maintain their preretirement standard of living as of 2010, low interest rates are not necessarily to blame, the CRR finds in an issue brief on the impact of interest rates on the national retirement risk index (NRRI).
“Households are less vulnerable than expected to today’s historically low interest rates, but higher interest rates would also provide no real cure to the problem of inadequate retirement saving,” the brief says.
A few factors explain the minor impact of low interest rates to senior households, including the muted effect interest rate changes have on annuity income.
“One’s initial thought might be that a doubling of interest rates would lead to a doubling of retirement income,” says the CRR. “But annuity payouts consist of a return of principal along with interest earnings. Since changes in interest rates only affect the interest portion of the annuity payout, the impact on the full annuity payout is much smaller.”
Another reason: financial assets for most households are only a “modest portion” of total wealth—only 10% for middle-income households aged 55-64.
The third reason has to do with housing wealth—a significant asset for many households—since the impact of changes in interest rates on the payout from a reverse mortgage is partially offset by changes in the amount that can be borrowed.
High interest rates typically produce more income on investments, and vice versa, and they also directly influence the amount that can be borrowed against the home through a reverse mortgage.
At a real interest rate of zero, for example, someone could borrow 64% of the value of the house under the federal Home Equity Conversion Mortgage program. With a 4% interest rate, though, only 30% could be borrowed, as lenders look to prevent the loan plus accumulated interest from exceeding the proceeds from the home’s eventual sale.
Chart credit: Issue brief authors’ calculations
Low interest rates unfavorably impact the amount earned on annuities, but there’s a silver lining, the researchers say.
“The change in the portion of the value of the house that can be borrowed offsets the direct effect of interest rates on annuity income,” says the white paper. “For example, an interest rate of zero increases the share of household at risk by 1.4 percentage points, which is the net effect of a 2.7-percentage-point increase due to lower annuity rates and a 1.3-percentage-point decrease due to the ability to borrow more against the house.”
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