WSJ: Reverse Mortgages Have an Undeserved Bad Reputation

The assumption that reverse mortgages should only be used as a last ditch effort to bolster funds, rather than a financial planning tool, has long hindered their effective use in helping retirees finance longevity. But considering the string of recent policy updates over the past few years and wealth of reverse mortgage research, one financial planner says it is time to lay those long-held misperceptions to rest.

More often than not, discussing reverse mortgages in the context of retirement planning typically focused on “perceived negatives” related to high costs or misuse of loan proceeds, says Wade Pfau, principal at McLean Asset Management and a professor of retirement income in the Financial and Retirement Planning Ph.D. program at The American College, in an column published by The Wall Street Journal this week.

“The assumption in financial and retirement planning was that reverse mortgages should only be considered as a last resort, once all other resources and possibilities had failed,” Pfau writes. “Well, a lot has changed in the past several years, and the result is that reverse mortgages have an undeserved bad reputation.”

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Pfau, who also serves as a member of the Funding Longevity Task Force, has focused extensively on the strategic use of a reverse mortgage in retirement planning. Just recently, he published a paper that appeared in the Social Science Research Network, highlighting the various methods to incorporate home equity into a retirement income strategy.

This research incorporates the realistic costs for reverse mortgages related to the upfront origination fee, closing costs and continued growth of any outstanding loan balance. Overall, the work is meant to show the benefits from using reverse mortgages even after incorporating their costs and despite their bad image with the public, Pfau noted.

“The reverse mortgage option should be viewed as a method for responsible retirees to create liquidity from an otherwise illiquid asset, which in turn can create new options that potentially support a more efficient retirement income strategy, such as more spending and/or more legacy,” Pfau writes.

One valuable strategy for using a reverse mortgage early in retirement, as opposed to a last resort, Pfau notes is the ability to manage the sequence of returns risk that retirees face.

“Retirees are more exposed to investment volatility because volatility has a bigger impact on financial outcomes when taking distributions from the portfolio as compared with when adding new funds to the portfolio,” he writes. “Reverse mortgages provide a buffer asset to sidestep this sequence risk by providing an alternative source of spending after market declines.”

Another potential benefit for taking a reverse mortgage early in retirement, Pfau adds, is using the line of credit feature to let the principal limit grow over time.

Because reverse mortgages are non-recourse loans, an added benefit he suggests is the possibility that the credit line may grow to be larger than the value of the home. In these instances, borrowers or their estates will not be on the hook for repaying more than 95% of their home’s appraised value when the reverse mortgage becomes due and payable.

“As the government continue to strengthen the rules and regulations for reverse mortgages, and as new research continues to pave the way with an agnostic approach about their role, we may be at a tipping point in which reverse mortgages become much more predominant in the years ahead,” Pfau concludes.

Read The Wall Street Journal article.

Written by Jason Oliva

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  • While otherwise describing reverse mortgages as cash management tools for the borrower, Wade then says: ” The thrust of these changes has been to help ensure that reverse mortgages are used responsibly, as part of an overall retirement income strategy….” While there are areas where retirement cash flow and income planning overlap, they are also very distinct. When a reverse mortgage is involved in retirement cash flow planning, there is risk of loss of the home while there is no such risk in retirement income planning.

    While Wade claims the following, he provides no citation: “…also the borrower and/or estate won’t be on the hook for repaying more than 95% of the appraised value of the home when the loan becomes due.” The 95% rule applies to subsequent home owners who obtain the home through the death of the last surviving borrower as estates, trusts, heirs, or beneficiaries, it does not apply to borrowers.

    The article itself has no analytics even though it cites the paper where that information can be found.

    • If you mean “risk of loss of the home” due to the borrowers’ failure to meet loan terms, I would agree. Otherwise, there is no such risk of “loss” of the utility value of the home; one is simply electing to use the home equity asset much as (and perhaps in lieu of) one would use an investment portfolio as a source of cash flow.

      The 95% rule also applies to borrowers in the event they sell their home for its FMV as determined by the HECM termination appraisal.

      My only quibble with Dr. Pfau’s piece is his choice of the word “income” vs the more accurate “cash flow”.

      • REVGUYJIM,

        Please point to the authoritative source for your position about borrowers being eligible to pay off a HECM at 95% of the appraised value of the home at termination. The 95% rule and heirs are addressed in a Q & A issued by HUD but borrowers as to the 95% rule are not addressed in that document.

        Only the principal residence can be used as collateral on a HECM; therefore, it is the only asset at risk with this mortgage. As to income, what collateral is at risk?

        As to risk from utility loss in value of the home, that applies whether there is a mortgage or not. (It is unclear why you brought up risk from utility loss which is a separate topic unrelated to mortgages.) The risk of loss of title always increases whenever the home becomes specific collateral for a loan.

      • REVGUYJIM,

        The 95% payoff rule does not apply to borrowers. It only applies to sales of homes to third parties (arm’s length short sales) and estates and heirs of HECM borrowers when they want to retain the collateral.

        If mortgagors (borrowers) want to keep the collateral, they must pay the balance due in full. I cannot find any authoritative (meaning issued by HUD) document stating that mortgagors have the right to retain the collateral by simply paying off the lower of the balance due or 95% of the appraised value of the home at the time of HECM termination.

        If you know of any authoritative documents (including loan documents) which state that borrowers (mortgagors) can pay off the balance due and keep the collateral for less than the balance due (), please provide that citation. I read this all of the time but it is but another example of an industry created and promoted myth.

      • REVGUYJIM,

        (RENEWED REQUEST)

        You say: “The 95% rule also applies to borrowers in the event they sell their home for its FMV as determined by the HECM termination appraisal. My only quibble with Dr. Pfau’s piece is his choice of the word ‘income’ vs the more accurate ‘cash flow.'”

        You are absolutely right as to a short sale. No one disagrees with that but Dr. Pfau takes that a step further when he says: “…also the borrower and/or estate won’t be on the hook for repaying more than 95% of the appraised value of the home when the loan becomes due.”

        Dr Pfau makes no distinction between a short sale and other forms of repayment including retaining title to the home. Borrowers cannot retain title by only paying off 95% of the then appraised value if that is lower than the balance due, although estates can.

        Again please provide the authoritative document where borrower repayment is limited to 95% of the then appraised value of the home (and the balance due is greater) where the borrower retains title to the home because that is what Dr. Pfau implies by using the word “repaying.”

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