In recent years, financial planners have shown the effectiveness of using a reverse mortgage line of credit to supplement a retirement portfolio. But while a line of credit can be a strategic part of a retirement income plan, there are often misconceptions related to how the credit line grows.
In yet another Forbes article focused on reverse mortgages in the past week, Wade Pfau, Ph.D., CFA, professor of retirement income at The American College, sets the record straight with an in-depth analysis of how a Home Equity Conversion Mortgage (HECM) works, grows and stands to benefit borrowers.
“The ability to have an unused line of credit grow is a valuable consideration for opening a reverse mortgage sooner rather than later,” Pfau writes. “It is also a detail that creates a great deal of confusion for those first learning about reverse mortgages, perhaps because it seems this feature is almost too good to be true.”
Pfau speculates that the motivation for the government’s design of the HECM program is based on the underlaying assumption that borrowers would spend from their line of credit sooner as opposed to later.
“Implicitly, the growth in the principal limit would then reflect growth of the loan balance moreso than the growth of the line of credit,” Pfau writes. “In other words, designers assumed the loan balance would be a large percentage of the principal limit.”
The line of credit, however, grows at the same rate as the loan balance, which if left unused, could become quite large.
“There was probably not much expectation that individuals would open lines of credit and then leave them alone for long periods of time,” he writes. “However…the brunt of the research on this matter since 2012 suggests that this sort of delayed gradual use of the line of credit can be extremely helpful in prolonging the longevity of an investment portfolio.”
Read more of Dr. Pfau’s analysis of the reverse mortgage line of credit growth.
Written by Jason Oliva