Retirement has become a frightening prospect for millions of
Americans who haven’t made adequate financial preparation
for it, yet face the likelihood of living much longer than
any prior generation of retirees. The Center For Retirement
Research at Boston College reports that more than half of
all households will not be able to maintain their standard
of living in retirement.
The
HECM reverse mortgage is a partial solution to the crisis.
It is partial because it is feasible only for homeowners who
have significant equity in their homes on retirement. But
that is a very sizeable chunk of the retirees who need help.
This article focuses on three seniors whose problems differ
in severity but each of the three is typical of millions of
others.
·
John retires at 65 with few
financial assets, is largely dependent on social security
for income, and still has a (paid-down) balance on his
mortgage.
·
Mary is in the same position
as John, except that her mortgage is paid off.
·
Leslie has no mortgage debt
and significant financial assets from which to draw
spendable funds, but faces the risk that the funds will run
dry while he is still alive.
John Pays Off a Forward Mortgage
The
received financial wisdom of my generation was that your
mortgage should be paid off by the time you retire. John
like so many others in his age cohort did not follow this
principle. He has a mortgage balance of $50,000 on a house
worth $110, 000, and is obliged to pay $540 a month until
the balance is paid off, which won’t happen for 7 years.
But
John can use a reverse mortgage to pay off the balance now.
This makes the best of a bad situation by replacing debt
that John must repay in monthly installments with debt that
doesn’t have to be repaid until he dies or moves out of the
house permanently. Being relieved of the burden of paying
$540 a month is the equivalent of having that much
additional monthly income.
The
unavoidable downside is that by using most of his reverse
mortgage capacity now, he retains little capacity to draw
spendable cash in later years. After repaying his mortgage
balance, only about $13,000 remains, which he can draw in
cash, or leave as a credit line for future use.
There
are a lot of Johns out there, but many are in the less
populated parts of the country where reverse mortgage loan
originators and counselors are hard to find. Getting the
word out about the availability of the reverse mortgage
option is a challenge I will be discussing in another
article.
Mary Takes a Tenure Annuity
Mary
has the same balance sheet as John except that at 65 when
she retires, her mortgage will be paid off.
This means that Mary
has more options than John in how she uses a reverse
mortgage. The principal options are a credit line for about
$63,000, which grows over time if not used, a monthly
“tenure” payment which will pay her about $331 a month for
as long as she lives in her home, or some combination of the
two. She could also select a monthly term payment, which
would be larger than the tenure payment but cease when the
term was over.
Since
Mary wants to supplement her income permanently, by as much
as possible as soon as possible, she will take the tenure
payment. However, this doesn’t commit her forever, since a
tenure plan can be modified at any time for $20 paid to the
servicer. For example, if Mary finds after 2 years that the
monthly tenure payment won’t be needed for awhile, she can
switch to a credit line of about $59,000. The line will grow
in size from that point on, and if she swings back to a
tenure payment after a few more years, it will be larger
than the one she had originally.
In the
opposite case, where she needs a larger monthly payment for
a limited period, she can switch to a term annuity, with the
option of switching back to a tenure payment or to a credit
line any time before the expiration of the term. The HECM
reverse mortgage is marvelously flexible.
Leslie Takes a Credit Line
Leslie
just retired at 65, and is now largely dependent for current
income on the wealth he managed to accumulate over his
working life. It amounts to $600,000 in financial assets
plus a house he owns mortgage-free worth $300,000. His
financial status is thus a lot stronger than that of John
and Mary, But Leslie has a richer lifestyle as well, and is
concerned about his ability to extend it indefinitely.
The
financial advisor who manages Leslie’s money tells him that
if he draws down his financial assets every year by the
amount needed to maintain his lifestyle, the probability of
running out of money before he dies is “only 5%”. That is
supposed to make him feel secure, but it doesn’t – it makes
him feel anxious. Nobody wants to spend their twilight years
hoping they die before reaching the point of impoverishment.
Of
course he could sell his house, which would increase his
investable assets to about $900, 000, but the cost of
substitute shelter could eat up most or all of the
additional investment income. Or he could wait until the
worst happened and sell the house then, but the thought of
having to move at that point in life is frightening.
The
solution for Leslie is to take a line of credit under a HECM
reverse mortgage, and leave it unused indefinitely. This
allows him to remain in his house while removing the threat
of future impoverishment if he lives well past his life
expectancy.
Based
on interest rates prevailing on July 3, 2013, Leslie at 65 could obtain a credit line of about $159,000 on his
$300,000 house. The line would cost him about $11,700 in
fees, which are financed – there is no out-of-pocket drain.
The credit line and debt grow over time at a rate equal to the mortgage interest rate plus the mortgage insurance premium, On July 3, these were 2.82% and 1.25%. Assuming that these rates stay the same, Leslie’s line would grow to about $238,000 in 10 years.
But
wouldn’t Leslie do better simply by waiting to see if the
line is needed, and if so, taking out the credit line then?
That would risk a
drop in the maximum available line, and perhaps a very large
drop. The main reason is that interest rates are very likely
to rise over the next few years. Higher interest rates
increase the growth rate of unused credit lines but
reduce the maximum size of new lines. This effect is
much more powerful than Leslie’s reduced mortality after 10
years.
And
there is still another reason. The Government which insures
HECMs assumes in calculating maximum credit lines that the
borrower’s home will appreciate at an annual rate of 4%. The
risk that Leslie’s home will appreciate by less than 4% is
assumed by the Government, it is a major reason why he pays
an insurance premium. If his house appreciates by more than
4%, on the other hand, he can refinance the HECM to take
advantage of it.
These
points are illustrated in the table below, which compares the
available credit line after10 years under different
assumptions about future interest rates and property
appreciation. Only if interest rates are stable and his home
appreciates by 4% a year or more does Leslie do better by
waiting to take out the credit line. If interest rates used
to calculate HECM credit lines escalate in the future, or if
Leslie’s house doesn’t appreciate, he does better taking the
credit line now -- a lot bette!.
Credit Line at Age 75 of Senior Now 65 With House Now Worth
$300,000
|
Scenario |
Take Line of $158,959 Now |
Wait 10 Years to Take a Line |
|
Expected
Rate 5.395%, Mortgage Rate 2.82%, Property Appreciation Rate
0% |
$238,640 |
$179,058 |
|
Expected Rate 5.395%, Mortgage Rate 2.82%, Property Appreciation Rate
4% |
$238,640 |
$267,087 |
|
Expected
Rate 10%, Mortgage Rate 7.82%, Property Appreciation Rate
0% |
$392,382 | $92,659 |
|
Expected Rate 10%, Mortgage Rate 7.82%, Property Appreciation Rate
4% |
$392,382 | $139,195 |
Note: The expected interest rate is used to calculate the credit line. The 10% rate is assumed --the HUD system does not recognize rates above 10%. The mortgage rate is used to calculate the growth of unused credit lines. The rate of 7.82% is assumed. The expected rates are assumed to remain unchanged throughout the 10-year period.
