Here’s How One Finance Professor Came Around to Reverse Mortgages

In the financial planning world, there are a few products that come with a tarnished reputation. A reverse mortgage is one of them.

But in recent years, professionals in the space have started to change their tune, recognizing the benefits the home equity loan may offer to a retirement income strategy.

For Wade Pfau, this view on reverse mortgages started in October, when he attended a meeting hosted by the Funding Longevity Task Force, a group that was formed by Security One Lending and Reverse Mortgage Solutions last year to eliminate reverse mortgage misconceptions among financial planners and regulators.

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Pfau — now a professor of retirement income at the American College in Bryn Mawr, Penn. — had been active in the financial planning world, having written for industry journals and spoken at leading conferences, but, he says, he didn’t know much about reverse mortgages.

Previous research in the Journal of Financial Planning by John Salter and Harold Evensky (both of whom Pfau knows), among others, have pointed him in the right direction.

Their work has influenced Pfau’s own research on the topic, as he uses it as a springboard to make the case for reverse mortgages in a recent Wall Street Journal column and in another article that quantifies the reverse mortgage standby line of credit.

Reverse Mortgage Daily caught up with Pfau to learn what the reverse mortgage newcomer thinks of the industry, of the product and of its misconceptions. Here’s what he had to say:

Reverse Mortgage Daily: In your short time in this industry, what have you learned about reverse mortgages? 

Wade Pfau: This is really something people don’t know a lot about. There’s a big misconception that you sign the reverse mortgage and the bank now has the deed to your home. But if you just use your home as a “last resort,” that’s constraining yourself. You could find a more efficient way to use your home equity and that’s what that standby line of credit can do.

At that [Funding Longevity Task Force] meeting, everyone was talking about how great a line of credit is, and now I understand it better. It’s because that line of credit just keeps growing no matter what the home price is. It’s a really good opportunity to protect the price of your home, because the line of credit can pretty easily grow to be higher than the value of the home as long as you live past your life expectancy.

RMD: What were your thoughts about reverse mortgages before the Task Force meeting? 

WP: I hadn’t given reverse mortgages proper attention yet. [My view was] really just more of an “I just don’t know a lot about them so I better remain skeptical” approach. You see all those commercials touting the benefits of a reverse mortgage — that’s kind of a red flag in my mind of “well I better remain skeptical about these until I learn more.”

There are a lot of financial products aimed at retirees that aren’t always trustworthy, so it’s good to be skeptical about anything before you dig into it.

RMD: What’s your take on the bad reputation of reverse mortgages?

WP: There are a lot of financial predators out there. The conventional wisdom of reverse mortgages was a sleazy advisor would get [seniors] to tap their home equity and put it all into a shady investment. But the new HECM rules prevent all that from happening.

RMD: How can lenders better market that to the general population? 

WP: Reverse mortgages may be really good, but the way they’re promoted [isn’t]. There are a lot of financial products that seem like they’re being oversold.

Sometimes salespeople overdo it and cross the line. Even if their sales pitch is correct, they make [reverse mortgages] sound too good to be true. There has to be a fine line there of explaining the benefits, but making sure to address any potential disadvantages or clearly explain why these benefits exist and that the government is regulating the industry.

RMD: From a consumer’s standpoint, how can a reverse mortgage fit into a retirement income strategy?

WP: I’m basically coming to the opinion that for a lot of people, it’s a pretty good idea to just open a standby line of credit as soon as the older spouse turns 62. Of course, people who are too poor may want to open a line of credit anyway, and for people who are very rich, it’s not going to make much of a difference.

But for the large middle-class, open it and it will grow throughout your retirement. Then you can use that line of credit as a part of your retirement income strategy. Even if you don’t end up needing it for retirement income, there’s this good potential that if you leave the line of credit alone, it can eventually grow to be worth more than the home.

If your home value decreases, your line of credit is going to continue to grow by at least 4.4% and could be higher if interest rates go up. So even if the home price goes down, that makes it easier [for the line of credit] to outpace the value of your home.

RMD: What are the pitfalls of using a reverse mortgage standby line of credit?

WP: It’s not going to be sustainable from the government’s perspective. The strategy could become too popular for its own good and then the government might stop letting the line of credit grow at the rate that it is.

Whoever signs up today [for a reverse mortgage] is going to get this great benefit that may disappear in the future.

Written by Emily Study

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  • Been educating financial planners and borrowers on this strategy for 15 years. Really comes down to whether you need to do a reverse mortgage or not. After 1,000+ reverse mortgages a small percentage saw this strategy. You can show folks #’s, projections, anything, but if you don’t need a reverse mortgage you wait. Is that the best thing to do? Maybe, maybe not, but it is today’s reality. Not sure why this will change all of a sudden. Maybe someday the credit line along with the purchase product will be a prominent part of the business, but until then, everyone in this business better hope the financial assessment doesn’t eliminate the majority of folks who need this program because that is where the business is.

    • reverseguy123,

      While H4P is interesting, it brings little financial value to those who are downsizing other than saving some duplicative costs and in some cases acting like a bridge loan while the existing home is being sold or allowing the existing home to become a rental. Yeah, if one wants to upsize it can help but then why place so much investment risk in the home or a rental in one’s latter years?

      As to mass affluent seniors, having the backing of financial planners and other financial advisors is crucial.

    • Couldn’t agree more. I have presented the program and our take on using it as a financial planning tool to at least 10 advisors who have seen a live presentation by John Salter. When asked only one of the advisors said they would recommend the standby line of credit idea to clients. We have received 3 leads from the one advisor who liked the idea and recommended it to his clients, and none of the clients wanted to do it because they did not see why they would spend the money on closing costs if they did not know they were going to use it. I understand why the industry has adopted this model (it attracts the least amount of regulatory scrutiny) but its really not effective.

  • “… because the line of credit can pretty easily grow to be higher than the value of the home as long as you live past your life expectancy.” Really?

    While I appreciate an influx of advocates from finance educators, the professor is lost in static home values and some odd notion about life expectancy. It is these kinds of statements which take away from the positive impact these advocates bring to the industry. Most of this stems from two factors: superficial knowledge of the principal limit growth rate and less than practical knowledge about how volatile home values can be.

    For example, I had one customer who never used any part of his line of credit for anything other than as the means to pay his upfront loan costs back in 2005. Then with little growth in his line of credit in the first two years of the loan, his line of credit exceeded the value of his home by almost 80%. He was 70 when he took out the HECM and even in terms of TALC life expectancy, he had hardly come close to his life expectancy at 72. It is the home value variable that caused this effect. His home value which was near the lending limit back in 2005 had fallen by over 60% by late 2007.

    As further evidence of such naivete, the professor adds: “The conventional wisdom of reverse mortgages was a sleazy advisor would get [seniors] to tap their home equity and put it all into a shady investment. But the new HECM rules prevent all that from happening.” While the reduced proceeds and first year disbursements limitations will to some degree mitigate such losses, how is it they will “prevent” them?

    Since when does a HECM have a minimum growth rate other than the ongoing MIP plus that borrower’s margin? Many of my customers have been experiencing growth rates of less then 2% for several years now due to a 0.5% MIP rate plus a 1% margin with a index rates of less than 0.5%. Even recent many originations have been done with a 1.25% MIP and a margin of 2.25% resulting in current growth rates of below 4%. So where does the minimum growth rate of 4.4% come from?

    Here are yet more words from the professor to ponder: “The strategy could become too popular for its own good and then the government might stop letting the line of credit grow at the rate that it is.” Is the credit line growth rate a problem? By termination, how many borrowers have taken all of the growth in the line of credit? It is hard to believe that the growth in the line of credit is a substantial threat to the MMI Fund as the professor conjectures.

    • Pfau’s 4.4% is no doubt derived from an assumed margin of 3, MIP of 1.25 and current 1-mo LIBOR of .15% – too much detail for this article. Unless one believe LIBOR yield will drop to zero, the minimum 4.4% growth on a 3.00 margin product looks like a pretty sure thing.

  • Great interview! Sounds like progress is being made slowly but surely. I agree with him that the overselling on television gives the impression that HECMs are in the “too good to be true” category. I’m thankful to the business those commercials have created, but it has pigeon-holed us to some extent.

    I don’t necessarily agree with Mr. Pfau that the standby LOC option might make the HECM unsustainable from the FHA fund’s perspective. While I hope the standby LOC becomes a popular option, how many will have the means and will power not to make draws for 10-15 years?

    What about those that sell their homes prior to using the LOC or those that pass away well before their life expectancy? What percentage of standby LOC customers will “break the bank” so to speak?

  • “It’s a really good opportunity to protect the price of your home, because the line of credit can pretty easily grow to be higher than the value of the home as long as you live past your life expectancy.”

    This statement is true if home values decline; however it seems that what this statement touts instead is the ability of the line of credit to exceed or outpace home appreciation over time, which also means exceeding the maximum claim amount at origination.

    This implies that, theoretically, the borrower can make a huge draw request against the line of credit and that the request will be honored.

    But, isn’t the Line of Credit limited ‘at least’ by the Max Claim Amount (MCA) and ‘at most’ by 150% of the MCA? Most loan agreements state that the Lender is not secured for payment to the Borrower above and beyond these limits, term and tenure payments notwithstanding.

    There must be a Policy-Wonk out there who knows? Clarification would be a good thing!

  • I have to agree with reverseguy123 and especially with The_Cynic. Parts of the article was good but for the most part most of us are aware of all what the professor has said.

    I question where the minimum growth rate of 4.4% comes from as well.

    However, many seniors look to us to be their guiding force in determining whether they want or need a reverse mortgage. Reverseguy123 is right in one sense that after you show the prospective borrower the projections and other information, they either need it or not. We need to do more than just show projections, we need to analyze thier individual situation and guide them accordingly.

    So many seniors after an interview feel a reverse mortgage is not for them but if enough time and patients would be spent with them, so many change their mind.

    Please, don’t misunderstand me, I am not saying reverseguy123 does not take the time and patients a senior deserves, on the contrary, withreverseguy123’s experience I am sure he does an A+ job with his clients.

    John A. Smaldone

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