Can a Reverse Mortgage Crash-Proof Your Client's Retirement?

It’s time to stop viewing reverse mortgages as simply a means of last resort for mass-affluent retirees running out of money, according to Phil Walker, vice president of strategic partnerships at Finance of America Reverse.

They can be used as a strategy for risk mitigation while at the same time growing investment portfolios, he argues.

“This gives the wealth management industry “a reason to engage the [reverse lending industry],” he says.

For example, following a down market, “don’t take the next income draw from the portfolio — take it from the reverse mortgage. 

“That will give you faster, more growth when the market rebounds” and “pulls a lot of risk from your existing retirement plan,” says Walker, who trains financial advisors on how reverse mortgages can benefit retirement plans.

That withdrawal strategy is among the findings in a study that he and two academics conducted, which was published in the Journal of Financial Planning in December.

Titled “To Reduce the Risk of Retirement Portfolio Exhaustion, Include Home Equity as a Non-correlated Asset in the Portfolio,” the white paper shows how tapping home equity with a reverse mortgage offers the most benefit for mass-affluent retirees. 

On average, this group has about $500,000 to $1.5 million in investable assets, Walker says.

The withdrawal strategy “dramatically reduces retirees’ exposure to volatile markets,” Walker adds.

FAR, a leader specializing in reverse mortgages, is the country’s largest wholesale provider, according to Walker.

Traditionally, wealth management has viewed reverse mortgages cautiously as “all risk and no reward: [Most advisors] can’t sell [them]. They have to refer them away. 

“But if the client has a bad experience, they can sue [the advisor] — and there’s no revenue to offset that risk,” says Walker, formerly an advisor with Merrill Lynch, Morgan Stanley Smith Barney and Raymond James.

Over the years, compliance concerns, abuses and lawsuits have cast reverse mortgages in a negative light.

Reverse mortgages, however, can be used “like annuities and insurance,” Walker says. But “compared to those products, they’re much cheaper.”

ThinkAdvisor recently held a phone interview with Walker, who is based in Visalia, California.

The reverse mortgage strategy that he and his colleagues discovered is “the easiest, cheapest alternative for those who need an alternate source of income” — while providing portfolio growth and “dramatic risk reduction.”

Here are excerpts from our interview;

THINKADVISOR: Your study points to “seismic changes” for the reverse lending industry, you say. What changes were needed?

PHIL WALKER: For a number of years, our industry has known we should be working with the wealth management community and the financial planning community at large. 

What has held that back was their view from a compliance standpoint that engaging us was all risk and no reward: [Advisors] can’t sell reverse mortgages — they have to refer them away.

[But] if the client has a bad experience, they can sue [the advisor], and there’s no revenue to offset that risk.

What’s the most important finding in your white paper?

The study has proven that a majority of mass-affluent retirees, the group with roughly half a million dollars to $1.5 million in investable assets, could benefit substantially from doing the new withdrawal strategy that we discovered. 

For those who need an alternative source of income, the easiest, cheapest alternative is tapping into the home equity and reverse mortgage.

It’s not just portfolio growth; there’s also dramatic risk reduction [that they’ll derive].

This kind of flew in the face of “if you do something to get more gain, you probably take on more risk and could lose money.” 

Just how does the withdrawal strategy you’re espousing impact a portfolio?

What we discovered was that it dramatically reduces the retiree’s exposure to volatile markets.

Volatility is a risk to a retiree because as the markets move up and down, so does your income. This strategy removes a lot of that, which is why it’s so momentous.

We don’t touch the portfolio holdings, yet we see all this growth.

Please explain how the new withdrawal strategy actually works.

[It’s based on a 2012 discovery] that following a down market period, instead of taking the next draw from the portfolio, you take it from the reverse mortgage. 

What we discovered is that this also reduces risk.

After a down market, instead of taking the next year’s income from the portfolio, let it sit there and rest. Instead, take the income draw from this alternative source — a reverse mortgage.

Please discuss the other big positive: more growth.

If you draw on the portfolio, you’re making it really hard to rebound because you took money out that could benefit from growth.

But if you leave it in, you’re getting substantially more growth. You still take the hit from the down market, but you just recover a whole lot faster. That was one of the findings in the new study.

So doing that over a 20- or 30-year retirement time horizon, you’re leaving as much money in the portfolio as possible to benefit from the rebound that eventually comes following a down market.

This has a compounding effect over time that helps seniors have substantially more money.

You claim that your study “points to a massive demographic shift for the reverse mortgage industry and strengthens its position as a wealth management solution for higher-net-worth people who are retiring.” What level of higher net worth?

The specific group of the mass affluent. The majority of clients in the reverse mortgage industry have less than $2 million in investable assets. They’re generally people that are going to run out of money during retirement.

When they start to run out, they call us and utilize our product. But now the mass affluent have a reason to engage us for a tremendous benefit also. 

Just how significant is this?

It’s momentous for retirees, for the reverse mortgage industry and for the wealth management industry. For the retirees, it pulls a lot of risk from their existing retirement plan. 

And all of a sudden, the wealth management industry has a reason to engage us because, as we know, their responsibility isn’t just growing wealth; it’s reducing risk.

We can do that on a level that hasn’t been discovered since modern portfolio theory was introduced in 1952. After all these years, we have a new fundamental in risk reduction. 

How come you didn’t make that discovery earlier?

Because of an old fundamental that’s no longer true: In retirement, all debt is bad. 

Ideally, you would prefer to be debt-free in retirement. But if the mass affluent aren’t using this strategy, they’re taking on unnecessary risk.

How open are financial advisors to recommending reverse mortgages to clients? Do you have to try to convince them that it’s a good thing?

That [attitude] has been changing more rapidly as they’re getting more exposure to clients that are getting reverse mortgages on their own. They’re learning the reality of how they actually work.

There are a lot of misconceptions with this product. From the 1950s through the 1980s, reverse mortgages were exclusively for desperate seniors who were about to lose their homes.

Around the late 1980s, the industry introduced a [government-backed] new product with a completely different purpose; the home equity conversion mortgage, or HECM.

How did that go over?

The financial world tried to put it in a box. When they found out that you didn’t have to make a monthly payment and you can get money out of a home, they went, “Oh, that’s a reverse mortgage.” 

The cost, the intent — everything was completely different from the previous product. It was taking the hard assets from real estate and giving them liquid features so it could be used in a retirement plan. 

Traditionally, if you wanted to access the money in your home and not have a mortgage to pay, you had to sell the home. But this gave you the ability to do the same thing and keep the house.

What’s the downside to a reverse mortgage?

There’s a risk just like any other financial product. The main downside is improper, or inappropriate, use — utilizing it outside of financial planning.

Sometimes people use it to buy things like an RV, or to go on vacation. Well, it’s their money. 

But from a planning perspective, before they do that, hopefully, they’ve taken care of a lot of other things, like long-term care planning and making sure they’ve got assets and income that are going to last through their life expectancy.

What’s in the fine print of a reverse mortgage?

Some people say they cost a lot. They don’t if you compare them to other financial products that might cost a little bit more than a traditional mortgage. 

But you don’t use these like a traditional mortgage. You use them like annuities and insurance. When you compare them to those products, they’re much cheaper.

What sorts of fees and interest rates must be paid?

A borrower can expect to pay typical lending fees, such as origination fees, closing costs and interest, as well as upfront and annual mortgage insurance, if applicable. 

Rates vary and are dependent on loan factors, which are similar to those of a traditional loan. 

But unlike a traditional loan, the loan balance grows over time.

What if you still have a traditional mortgage on your home?

The reverse mortgage pays off any existing mortgages. It’s like a refinance: You’re getting a new mortgage that’s going to pay off the old mortgage. So you’ll have just one mortgage on your home: your reverse mortgage.

For most American retirees, their home is free and clear. They don’t have a mortgage on their house.

So the loan isn’t paid off until the borrower sells the home, moves or is deceased?

That’s part of what defines a reverse mortgage. When the last borrower passes away, sells the home or permanently leaves the home, that’s when the borrower or heirs decide how to pay it off. 

If they choose to sell the house, the amount borrowed plus interest is paid off; and all the remaining equity goes to the borrower or their heirs.

The heirs also have the option to buy the property.

What happens if borrowers don’t pay insurance or property taxes?

Just like a traditional mortgage, failing to pay property charges or property taxes could lead to default and result in the loan needing to be repaid.

Some borrowers have a LESA, or life expectancy set-aside, from loan proceeds to pay the taxes and insurance automatically.

Pictured: Phil Walker, vice president of strategic partnerships, Finance of America Reverse