Huffington Post Explores Role of Life Expectancy in Reverse Mortgages

In a post from reverse mortgage expert Jack Guttentag, the Huffington Post explores an interesting twist to a potential Home Equity Conversion Mortgage borrower’s mental calculus — the knowledge that people in his family tend not to live very long.

The bulk of Guttentag’s piece explores the typical options available to a 61-year-old retiree who wants to relocate to a warmer climate. While the man has enough cash to cover the price of the home and has two pensions, Guttentag, a professor of finance emeritus at the Wharton School, walks through the various ways he could use a HECM to supplement the transaction or his future retirement plans, eventually rejecting a HECM for purchase; because his cash generates little interest income, Guttentag recommends using it to buy the house instead of saving. In order to supplement the couple’s income while deferring Social Security as long as possible, he advises that they take out a reverse mortgage line of credit or receive fixed HECM payments until age 70.

It’s only at this point that the retiree drops a bomb: People in both his and his wife’s family tend not to live very long, and neither one expects to live much past age 78. Though it’s a decidedly morbid thought, life expectancy plays a major part in how people should plan for their retirement years, and Guttentag notes that it changed his entire strategy for the man.

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“For one thing, it upended the decision on when to take Social Security,” Guttentag wrote. The option of taking fixed payments until age 70 no longer made sense, since the extra income gained at that age would not make up for the eight years of deferred cash if the man and his wife didn’t think they’d see their 80s or 90s. 

“Hence, I retracted my recommendation for using a HECM to provide a temporary income supplement, since the purpose of the supplement was to enable the senior to delay taking Social Security,” Guttentag said.

He still advised the potential borrower to take out a line of credit, even though a shorter life expectancy likely means that the couple could live off of the man’s pensions without ever needing to tap into the HECM: “No retiree wants to live with even a small risk that they can become impoverished by living too long,” Guttentag wrote, noting that a small loan balance deduction from the estate represents the only potential downside. “The HECM credit line is insurance against that cost.”

Read Guttentag’s full breakdown here.

Written by Alex Spanko

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  • The article is illuminating not because Dr. Guttentag comments on three strategies on the uses of HECM proceeds but because he brings up risk principles to evaluate those uses. Some of those principles rightfully strike at the heart of industry conventional wisdom.

    For example in this day and age, it makes little sense to use more HECM proceeds than is needed to close a HECM for Purchase; it is best to keep a line of credit. The relative of Dr. Guttentag was making too little on the money he had to justify not using it in the purchase transaction. Instead the purchase transaction as structured represented more of a Standby HECM. His worry was rightfully focused on what would result, negative arbitrage which is the condition where money is borrowed to keep an asset but the return on the held asset is less than the accrued costs of the debt. (Borrowers should take caution on advice provided by an asset manager who has a management fee at stake in the ultimate decision. That advisor has a conflict of interests in providing that advice.)

    Dr. Guttentag does a reasonable job of providing an overview of the risk point of view to seniors when evaluating HECM proceeds for use in bridging cash needs for the period from 62 to 70 when they may be deferring the start of Social Security benefits. He misses the added costs of interest and MIP. He also fails to provide a clear picture of the extent of risk over time. He also only sketched the theoretical payback period and the risks during that period.

    All in all, the article was the best Dr. Guttentag has provided into some of the financial strategies we see being advocated today. The problem with Dr. Guttentag is that his ideas and principles seem more based on experiences and anecdotes than on theoretical analysis. This means that at times he advocates strategies before he sees, understands, and evaluates the related risks.

  • “No retiree wants to live with even a small risk that they can become impoverished by living too long,” Guttentag wrote, noting that a small loan balance deduction from the estate represents the only potential downside.

    Sadly, the myths and misconceptions surrounding our product STILL result in the vast majority of retirees feeling that they have take the stated “risk”. Maddeningly, their advisors either refuse to educate themselves or are unwilling to deal with the ‘client push-back’ they get if they broach the subject.

    The winners are the kids who inherit the mortgage-free home and immediately sell for cash while their parents lived their last years less comfortably than they could have.

    • REVGUYJIM,

      Your first paragraph is misleading. Here is what Dr. Guttentag actually said in full: “The cost, if the line is not used, is the small HECM loan balance which would be deducted from the house sale proceeds that accrue to the borrower’s estate.”

      As Dr. Guittentag points out, it is only if the line of credit is NOT used is there a small deduction not from the estate but rather from “house sale proceeds.” Generally and currently In the industry, borrowers will have an accrued cost of 0.5% in FHA upfront insurance, maximum origination fees, and junk fees totaling about $11,000 on a $400,000 home for about a $200,000 line of credit if the youngest borrower is about 62 and the only UPB are the upfront costs of the HECM.

      So to get the HECM line of credit free of any debt but its upfront costs, the cost per dollar reserved now for perhaps future use is 5.5%. If the proceeds remain unused and the effective average interest rate is 5.75% for 35 years, the balance due will be $126,568. If the home rose in value 3.3% per year after 35 years the value of the home will be $1,267,598 but the available line of credit will be $2,301,230.

      Some will say cash in the line of credit but what if the cause of the termination of the loan after 35 years is death? What if the borrower has sufficient income in the years leading to death that the borrower did not pay attention to the line of credit? What is senility prevents the borrower from making well reasoned decisions?

      If the line was never touched, I do not call a cost that is 10% of the value of the home “small.” It is atrocious. Some will equate it to insurance but is it? The proceeds from most insurance policies do not have to be repaid, period. HECM proceeds have to be repaid and not only repaid but repaid with interest and FHA insurance.

      So while I promote the HECM product, applicants beware of the various strategies being promoted today. Not all of them fit your profile and some can be detrimental to your estate. We plan but unknown life events plague almost all planning.

      So, REVGUYJIM, I cannot say I agree with your comment. It lacks disclaimer and the discipline needed to properly advise seniors.

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