Reverse mortgages have been around for decades, even before the Department of Housing and Urban Development created the Home Equity Conversion Mortgage (HECM) program in the late 1980s. But while these financial products aren’t necessarily new, today they are becoming a “disruptive” way to leveraging home equity, says one reverse mortgage researcher.
In the spirit of Silicon Valley, where the term “disruption” has become a buzzword among tech companies looking to radically change the conventional way things are done, reverse mortgages are disrupting long-held emotional attachments tied to the home and how it can be used in building retirement wealth, according to a recent webinar from the Financial Planning Association (FPA), featuring Barry H. Sacks, a practicing tax attorney in San Francisco who has researched the effects of reverse mortgages in retirement planning.
In February 2012, the Journal of Financial Planning published a report Sacks co-authored that analyzed the use of home equity via a reverse mortgage. The report mathematically showed how a reverse mortgage line of credit feature can be used to supplement retirement income.
Expounding on the report’s findings during last Thursday’s FPA webinar, Sacks discussed how HECMs can “reverse” the conventional wisdom that has been anchored by perceptions that one’s home is sacrosanct, and that once the mortgage has been paid off, it should never be encumbered to any debt.
“In fact, it’s a wrong-headed idea,” Sacks said. “The notion that you should wait late in retirement before you start thinking about a reverse mortgage is contrary to the way sequence of returns risk can be overcome.”
Using a reverse mortgage line of credit as part of a coordinated retirement strategy can help retirees—specifically, the “mass affluent” who have invested assets in the range of about $500,000 to $1.2 million, and home equity in the same range—who are drawing on securities portfolios like 401(k) accounts or rollover IRAs, Sacks said.
“A small draw from a reverse mortgage credit line at the right time increases the long-term growth of the securities portfolio, such as a 401(k) or rollover IRA account,” he said.
This can be a critical strategy for retirees, considering the most frequent cause of retirement account exhaustion is the sequence of returns risk.
“The conventional wisdom for dealing with risk of exhaustion is a passive strategy,” Sacks said. “Conventional wisdom says: ok, let’s not worry about that until we run out of money. This is a wait-and-see approach.”
When faced with portfolio depletion, using a reverse mortgage as a last resort can prematurely exhaust one’s portfolio much sooner than if a person took a line of credit earlier during retirement.
Per a comparison example provided during the webinar, two people named John and Jim each start off in Year-1 with a retirement portfolio of $500,000 at age 65. Each experience the same investment performance over the course of a 30-year retirement period.
John, however, embraces the conventional wisdom of taking out a reverse mortgage later in life and only does so once his portfolio has been exhausted in Year-24.
“New wisdom” Jim, on the other hand, gets a reverse mortgage with a line of credit feature in Year-2 of his retirement when he’s 66 years old. Jim then draws from his standby line of credit in years following negative returns to his portfolio in years 2, 3, 6 and 23.
At the end of a 30-year retirement, Jim had drawn $295,000 from his reverse mortgage credit line, owed $692,000 on the reverse mortgage loan, but left an investment portfolio of $1,086,000—more than doubling his portfolio value since he retired.
John, who ran out of money on the 24th year, had drawn a total of $447,955 over the course of the seven years he had his reverse mortgage line of credit, but without any money left in his retirement portfolio.
“That is a remarkable example of the synergy that comes from the coordinated use of a reverse mortgage credit line,” Sacks said. “This is crucial because there is such a risk of people running out of money in later years.”
Written by Jason Oliva