Pfau: Reverse Mortgage Line of Credit Can Protect Against Economic Shock

The reverse mortgage line of credit can be a major tool for those at or near retirement to weather the economic shock of the COVID-19 coronavirus pandemic, particularly because sequence of returns risk amplifies investment volatility. If a retiree has a reverse mortgage in place to draw from while the market remains volatile, then they stand a better chance of weathering the storm caused by the current crisis.

This is according to Dr. Wade Pfau, professor of retirement income at the American College of Financial Services and founder of RetirementResearcher.com, in the latest episode of The RMD Podcast.

In terms of the elements that have caused the most material impact on a person’s ability to adequately fund their retirement, it centers on two factors: low interest rates and market volatility, he says.

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“[The biggest impact on retirement] is kind of a combination of two factors, and the one that’s been ongoing is the low interest rate environment and how lower interest rates really make retirement more expensive to fund,” Pfau says. “And then, of course, with the market volatility in the market downturns, that can affect people’s ability to really sustain the same lifestyle. They may have anticipated that their portfolios [would be] significantly larger than they might be today, depending on how their asset allocation and everything played out.”

Because of a reverse mortgage line of credit, having the ability to draw on that instead of investments during a period of market volatility can likely make a major difference in the financial health of a retiree during and after the current crisis, Pfau says.

“Even if the overall market recovers, a retiree spending from their portfolio might not get to enjoy that recovery,” Pfau says. “And that sequence of returns risk amplifies the impact of investment volatility. So, that’s where a reverse mortgage can fit into this in a number of different ways to help alleviate that risk on the investment portfolio.”

The growing line of credit can act as a buffer between the retiree and the economic volatility, whether through refinancing an existing mortgage or even in reducing fixed expenses in early retirement, he says.

“[Y]ou get a source of spending so that you don’t have to use as high a distribution rate from your investment portfolio,” he says. “In particular during today’s environment, helping to leave the portfolio alone and not spend from it after a market downturn and sourcing that spending from the reverse mortgage line of credit can really help to preserve the investment portfolio, and to create long-term positive impact net as a piece of a reverse mortgage.”

Dr. Pfau also discusses the receptivity of financial planners for reverse mortgages during the current crisis, his “origin story” in terms of what convinced him of the viability of the products, as well as how the pandemic is affecting his own day-to-day operations.

Listen to the new episode of The RMD Podcast for the full discussion.

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  • Some today talk about the HECM as if it is an asset. Clearly it is not.

    Some describe a HECM line of credit of $100,000 like a saving account of $100,000. They say if you take $10,000 out of the savings account the balance goes to $90,000. They correctly say that if they take $10,000 out of the $100,000 the amount remaining is $90,000. From that they conclude that the line of credit is an asset, just like a savings account. They are right until they conclude both are assets.; only the savings account in this case is an asset.

    HOWEVER, with the HECM line of credit when the $10,000 is taken from the available $100,000 HECM line oht ylf credit assumed above not only does the amount available drop from $100,000 to $90,000 BUT the HECM unpaid principal balance increases by $10,000. So if the HECM line of credit is an asset (WHICH IT IS NOT) economically when $10,000 is taken not only does the 1) amount available drop $10,000 but also 2) a debt increases by $10,000, meaning that for every dollar taken, economically TWO dollars are lost. I know of no asset that works like that.

    The amount shown as available in the line of credit is not an asset. It is a notion from the lender as to how much more the lender is willing to lend the borrower as long as there are no defaults and a request for funds out of the line of credit when added to the unpaid principal balance does not exceed the Maximum Mortgage Amount (also known as the Maximum Principal Amount).

    There are two primary conditions for an item to be considered an asset: 1) the item must be owned and 2) it must have value. To be owned means that the owner has control of the asset unless somehow legally it is transferred to an agent for safe keeping. As long as there are conditions on receiving the amount requested as is the case with a HECM line of credit, the amount as available is simply a notion, not an asset. To have value, the item must have value not just to the owner but to unrelated third parties as well. Value is normally established by a market, such as the stock market, financial institutions, diamond market, used car market, jewelers, commodity markets, etc. The HECM line of credit only has value to the borrower. There is no market for the borrower to sell his/her available HECM line of credit.

  • I pretty much agree with everything Dr. Wade Pfau stated in this article. In fact, I made a comment yesterday in the RMD on an article and echoed very similar philosophies! My comment was as follows:
    – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
    By John Smaldone:
    April 6, 2020 at 10:30 am

    I realize this is a bad time in our great nation for all of us, however, those of you in the reverse mortgage space should be still trying to make calls and helping seniors in need.

    Right now, there is more equity is out there in Homes owned by seniors 62 years of age and older than ever before! This is a time when many seniors can use a reverse mortgage the most.

    Most seniors have children and grandchildren that may be in financial difficulty. If many of these seniors knew more about a reverse mortgage, what a time for them to take one out and be there with the financial aid for their family!

    There are many other reasons seniors could use a reverse mortgage, with the stock market so volatile, what a hedge the reverse mortgage can be for them!
    There are so many more reasons for taking out a reverse mortgage today. I also realize it is almost impossible to go out into the public sector to originate directly.

    However, there are many lead sources and many data sources available to everyone so they can locate good qualified senior Homeowners. Plus, what about your past client base, great time to call on them, see how they are and at the same time, ask for referrals! Call some financial planners on the phone, they are taking calls, great source to be talking to.

    A lot we can still do to keep busy and help our seniors in need!

    John A. Smaldone
    http://www.hanover-financial.com
    – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
    As you can see the similarities in what I commented on yesterday compared to what Dr. Wade Pfau stated in his article.

    However, Dr. Pfau, covered other important areas as well. I just found it very interesting his article coming out today and my comment yesterday.

    Great article Dr. Wade Pfau!

    John A. Smaldone
    http://www.hanover-financial.com

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