In some cases, the perceived high costs of reverse mortgages deter otherwise eligible borrowers from tapping into their home equity for retirement purposes. But financial experts suggest that if these products came equipped with substantially lower setup fees, a new case could be made for reverse mortgages in retirement planning.
Reverse mortgages are often overlooked by retirees who could potentially benefit from these products. Even among those who have reviewed reverse mortgages as a potential funding source, the vast majority of retirement age adults largely misunderstand reverse mortgages, as evidenced by a survey from The American College of Financial Services earlier this year.
“Reverse mortgages do have a negative image with the public,” said Wade Pfau, director of retirement research at McLean Asset Management in McLean, Va., during a webinar this week hosted by Retirement Experts Network.
Much of the negative public image, Pfau said, relates to reverse mortgages of pre-2013, before many of the significant changes to the Home Equity Conversion Mortgage (HECM) program were enacted.
“Some things have changed,” he said. “The government has changed rules around protecting consumers, making sure consumers have adequate resources so they don’t spend down home equity and can’t meet their obligations.”
In the past, reverse mortgages also had high costs, Pfau said, noting circumstances where it cost more than $10,000 just to set up the loan. But today, some companies now offer HECMs for a low, one-time setup fee of $125. One such company is Reverse Mortgage Funding LLC, which sponsored the Retirement Experts Network webinar.
The webinar, co-hosted by Tom Dickson, who leads RMF’s Financial Advisor Channel, served to educate financial services professionals on refreshed ways of thinking about reverse mortgages, particularly within the context of retirement income planning. This involved a basic overview of the HECM program, including the recent program changes post-2013, as well as a variety of simulations depicting how a reverse mortgage can fit into a financial planning client’s retirement plan.
One scenario assumes a 62-year-old client with a home worth $625,500 in Pennsylvania. By taking a HECM line of credit, this client has $327,500 available to them at the time of the credit line’s inception. If the credit line is left to grow, after 10 years, the available proceeds available to the client will have grown to $613,365. By year 20, the credit line will have grown to $1,149,193.*
With this pricing option, the borrower receives a lender credit covering nearly all closing costs. The upfront cost of $125 is for a non-refundable independent counseling fee, on average, which the borrower pays directly to the counseling agency.
“This [reverse mortgage credit line] can basically provide another deferred income vehicle,” Dickson said during the webinar.
Opening a HECM line of credit can basically serve as a “put option” on the value of the home that can protect borrowers in the event that their home price falls in value, Pfau said.
“If interest rates don’t increase in the future, eventually the line of credit will grow to be more than the home value,” Pfau said. “If you start to introduce risk for home price fluctuations and the potential for rates to increase in the future, by age 82—for someone who opens a line of credit at 62—there’s a 50% chance that the line of credit can grow to be more than the value of the home.”
Unlike most retirement strategies and investments, where low interest rates could hurt, today’s current low rates are particularly beneficial for HECMs and the retirees who use them.
“Reverse mortgages are one of the interesting tools that work better in a low interest rate environment,” Pfau said. “Normally, low rates are bad for retirees—it makes retirement more expensive. Opening the reverse mortgage is one of the few strategies out there, relatively speaking, that benefits from a low interest rate environment.”
*This scenario assumes (1) 62-year-old borrower; (2) PA home valued at $625,500; (3) LOC will grow at 1.25% above the adjustable-rate mortgage, which uses the 1-year LIBOR plus a margin of 3.375%. Initial APR is 4.741% as of 6/21/16, which can change annually. Also assumed: 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 9.559%; (4) the growth rate remains at 5.85%; (5) no draws by the borrower.
Written by Jason Oliva