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April 06, 2016 at 02:11 PM
Using home equity conversion mortgages — commonly known as reverse mortgages — strategically can help improve clients’ retirement sustainability and build a larger legacy to leave their heirs, according to Wade Pfau, professor of retirement income at The American College and director of retirement research at McLean Asset Management and inStream Solutions.
Conventional wisdom on reverse mortgages or HECMs is that they are irresponsible, expensive or a last resort, and has made them unattractive to many retirees and their advisors.
“I was in the same situation as many advisors of knowing about the conventional wisdom, which is that reverse mortgages are generally a bad idea,” Pfau said on a webinar for the Financial Planning Association on Wednesday. After joining a study group on the products, he changed his mind, finding reverse mortgages are a “viable retirement income tool” and can be useful in managing sequence risk.
“I think it’s really important for advisors who may have done their due diligence about reverse mortgages 10 or 15 years ago to look at what all has changed starting in 2012 and to do their due diligence over,” he said.
There are four ways to manage sequence risk in retirement, according to Pfau. One is spending conservatively by employing the familiar 4% rule, for example.
Flexibility in spending is also important to managing sequence risk. “If you’re able to cut your expenses when the market declines, you don’t have to sell off as much of your portfolio at that point,” he said.
Advisors can also reduce volatility for their retiree clients by building a retirement income bond ladder, incorporating income annuities or using a funded ratio to manage asset allocation.
Creating “buffer assets” to avoid selling at losses is the final way to address sequence risk, and that’s where reverse mortgages come into play.
Understanding Reverse Mortgages
Reverse mortgages can be complicated, Pfau said. “I think one of the most difficult things to understand is the line of credit on a reverse mortgage and why it’s able to grow over time.”
The HECM program is administered by the Housing and Urban Development Department and Federal Housing Authority.
Policywise, there have a been a number of changes to HECMs, Pfau said, that make reverse mortgages more attractive. To qualify for a reverse mortgage, borrowers now have to undergo a more complete financial assessment. In the past, some investors used reverse mortgages inappropriately or irresponsibly. “It’s not really meant to be the case for someone who’s desperate,” Pfau noted.
Family misunderstandings between children who expected to inherit a family home when their parents passed away also led to a “negative image that wasn’t really justified,” Pfau said.
New regulations have eliminated the risk that a non-borrower spouse could be pushed out of the home on the death of the borrower spouse. Pfau also noted that the perception that the borrower loses the title to the home when he or she takes a reverse mortgage is a myth.
High costs can still be an issue, he acknowledged, but he said it’s still worthwhile for potential borrowers to shop around. “Unfortunately, there’s no central clearinghouse type of service for comparing different options from different lenders, but the initial costs on a reverse mortgage can range from anywhere between $100 up to more than $10,000,” he said.
Stigma over taking on more debt, especially if they’ve finally paid off their mortgage, is another obstacle to using reverse mortgages for eligible clients, but Pfau said there’s “probably a better way to frame reverse mortgages.” When clients spend money from their retirement portfolio, they don’t think of it as debt; Pfau said spending from home equity can be viewed the same way. “You have to compensate for that through paying back the loan balance, but the home is the collateral on that loan, so you’re really just spending down your home in the same way you might spend down your investment portfolio.”
To qualify for a reverse mortgage, borrowers must be 62 or older, and have equity in their home. They must also prove that they’re able to pay property taxes, homeowners’ insurance and continued maintenance on the home.
