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.”
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