Reverse Mortgage Credit Line Strategy May Benefit More Retirees

The reverse mortgage line of credit strategy may have concrete retirement benefits for a wider array of consumers than previously thought.

Previous research into the Home Equity Conversion Mortgage line of credit option had focused primarily on people who had twice as much retirement savings as their home values, according to researchers Peter Neuwirth, Barry Sacks, and Stephen Sacks. Curious about how HECMs might allow other types of retirees to maintain cash flow throughout their golden years, the team decided to analyze strategies for multiple types of retirees, including the “mass affluent” and the “almost-affluent.”

Their results, including their “rule of 30” for retirement cashflow, were published in this month’s Journal of Financial Planning.

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Within these categories, the researchers examined different proportions of home wealth and retirement assets: For instance, a regular “almost-affluent” person had a home worth $150,000 and savings of $300,000 at the start of retirement, while a “house-rich, almost-affluent” person had house worth $300,000 and savings of $150,000.

The team then ran two types of retirement projections for the different kinds of retirees: One in which they set up a standby reverse mortgage line of credit at the outset of retirement and used the proceeds during down markets, and one in which they drew down their portfolio entirely before taking out a HECM.

The results had two clear takeaways: The first strategy routinely outperforms the second for all types of retirees studied, resulting in significantly higher probability of a person’s cash lasting for the duration of a 30-year retirement. For instance, someone with an $800,000 house and $400,000 in savings would have a 90% chance of maintaining steady cash flow for 30 years; that number would drop below 30% for the second strategy.

The spreads aren’t that stark for all of the scenarios — for instance, the “almost-affluent” retiree would have a 90% or 80% chance of steady cash under either scenario — but the first strategy comes out on top each time.

In addition, the researchers found that using the first strategy results in a steady 90% chance of retirement success for a wide variety of home-to-savings ratios. In each of these scenarios, the initial distribution ended up being one-thirtieth of the total retirement income — resulting in the “rule of 30.”

This would compare favorably to the standard “four-percent rule,” which stipulates that retirees should only withdraw 4% of their entire account each year. For instance, under the 4% rule, that almost affluent retiree would be drawing $12,000 per year; under the rule of 30, he or she could net $15,000 per year, the team found.

“A simple rule of 30 can be used by a broad range of retirees to help determine how much retirement income their total retirement resources can provide, with a small probability of outliving those resources,” the researchers wrote. “The availability of this rule can potentially make retirement income planning more straightforward for a large number of individuals currently considering their future retirement income needs.”

“As a result, establishing a HECM line of credit as early as possible can provide the almost-affluent retiree — particularly if he or she is house rich and cash poor — with a significantly higher retirement income than a later establishment of the credit line, while reducing the probability of exhausting his or her assets,” the researchers conclude.

Written by Alex Spanko

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  • WARNING: The linked article is dated since it relies on information prior to the changes made on October 2, 2017. Also this post is inaccurate in some of its summary of the linked article.

    The authors depend on the line of credit growing at an annual rate of 5.8% based on assumptions dating back to October 1, 2017. If the assumptions were more reflective of changes that have become applicable on Monday (10/1/2017) the annual growth rate would be much closer to 5%, the principal limit would be lower, the net principal limit would be lower not only because of the latest principal limit factors and the higher initial MIP of 2% rather than the commonly used assumption used before October 2, 2017 of 0.5% for initial MIP.

    With a reduction of almost 13.8% in the annual growth rate to the line of credit and a reduction to the net principal limit of about 18.6%, the positive results displayed for the first strategy is now apparently overstated. Based on the principle of conservative, the projection also seems overstated by the rates of return expected on investments. Combine the effects of recent changes to the HECM and aggressively assumed high return on investment assumptions and one must conclude that the article is now so inaccurate as to be misleading as to its overall results and conclusions.

    As to errors in the summary above, the post fails to present the assumptions correctly in the principal example used by the authors in the linked articles. The blog writer states above: “Within these categories, the researchers examined different proportions of home wealth and retirement assets: For instance, a regular “almost-affluent” person had a home worth $150,000 and savings of $300,000 at the start of retirement, while a “house-rich, almost-affluent” person had a retirement fund of $300,000 and a house valued at $150,000.” In essence the writer says both seniors have total assets of $450,000 consisting of homes worth $150,000 and they each have $300,000 in other assets with one having savings of that amount and the other, a portfolio worth that amount. If this were true all other things being equal, both seniors would have the same principal limit and the only thing different would be the growth and taxes on distributions from the retirement fund versus savings. Based on the assumptions used by the blog writer, the value of the linked article was de minimis to begin with.

    Yet the actual article shows that the almost affluent has a home worth $150,000 with a retirement portfolio of $300,000 and the house-rich has a home worth $300,000 with a retirement portfolio of $150,000. Accuracy in reporting assumptions in an example is
    crucial in properly representing the contents of another’s work.

    The linked article emphasizes the importance of cash flow in retirement planning but suddenly reverts to saying: “If, as some economists project, the use of home equity for generating retirement income grows in prevalence in the coming years….” Home equity does not, has not, and even in the future will not result in retirement income. What the authors failed to say was that home equity can generate cash inflow through vehicles such as HECMs.

    The authors go on to say: “As a part of that analysis, the following question was explored: is there an optimal percentage of total retirement income resources that a broad range of retirees could withdraw (from one or both sources) each year that would maximize retirement income while minimizing the probability of exhausting all assets before the end of retirement?” Yet their analysis looks at not just retirement income but cash flow. It is sad that the professors of a specific aspect of retirement finances, retirement income, have so over influenced the articles exploring the use of maximizing cash flow in retirement that they have forced the use of incorrect, imprecise, and inaccurate use of terminology in such articles. Such incorrect terminology leads to false, imprecise, and incorrect conclusions.

    In conclusion, the linked article is now so out of date that it is NOW misleading and the summary above does not properly represent the assumptions reflected in the examples. Let us hope that the now outdated article will quickly be replaced. It is an interesting start to its rule of 30.

  • Haven’t read the article in detail yet, but enough to see that pre-Oct 2 HECM program parameters were used in the analysis.

    Would love to see a comment by the authors as to the impact of the Oct 2 HECM program changes on their results and conclusions.

    • REVGUYJIM,

      Yes, some brief update may be helpful but until we see the practical margin spread for a few months, any update would have to be tweaked to stay useful.

      The only thing I can tell you is that the rule of 30 itself no longer seems to relevant as is the case with the 5% rule and perhaps other strategy concepts. The current changes are so significant that to remain correct, changes must be made such as those promoted by Dr. Guttentag. We are just in a different period in the history of HECMs.

  • I don’t see a distinction here? For instance, a regular “almost-affluent” person had a home worth $150,000 and savings of $300,000 at the start of retirement, while a “house-rich, almost-affluent” person had a retirement fund of $300,000 and a house valued at $150,000.

    • Someone I know tried to attend your webinar today but was disappointed. He said you were not prepared. That did not reflect well on his opinion of how well you have designed your concept.

      With my friend you had your chance and fell flat.

  • @James_E_Veale_CPA_MBT:disqus what do you know about Reverse Mortgages in divorce proceedings? I have a male friend who is going through a divorce settlement and is trying to prove Reverse Mortgage can be income. His ex has one and the judge did not see Reverse Mortgage as income even though his ex is receiving payment for their household despite it being in “check form”. His lawyer had no understanding of Reverse Mortgage and was not much help at all. Is there anything that can be done to prove or establish Reverse Mortgage as income? If not what path should I tell him to go down in order to at least give him a chance at a reasonable life without going broke while paying is ex. There are no children involved and they are both over the age of 60. I thank you in advance for any advice you can give.

    • I am no lawyer nor am I a judge. I have no personal experience with divorce but I have had a number of clients who have had as did my maternal grandfather and my father-in-law, both far more than once.

      In California I have served as an expert witness on asset valuation in divorce matters. A reverse mortgage is not an asset of either spouse but rather a debt. Debt does not produce income since it must be repaid in full. As a nonrecourse mortgage where the collateral is the principal residence of the borrower, title to the home serves as payment in full when the balance due exceeds the value of the home.

      The judge is correct. By taking out more cash, all the borrower is doing is adding the exact same amount to the balance due. Debt must be repaid but income does not. A check must be examined as to its source. Since you have done that, it is clear the check is not coming a source of income, like a salary, a pension, interest, dividends, an annuity, or some other source of income but rather debt.

      Now if the cash was already in the bank as of the date of valuation, the cash would normally be a divisible asset and the debt a claim that would have to be analyzed by the court as to who owed what but in most cases if the home was owned equally, the debt would follow the ownership percentage.

      • For precedent, could also check with means-tested programs like SSI and/or Medicaid, neither of which consider RM proceeds as “income” for your reasons cited.

      • Interesting but unless there is no precedent on loan proceeds including HELOCs in general in the divorce law of the state law controlling the divorce proceedings, the citations could prove superfluous.

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