The question of financial security (running out of money) in retirement continues to be the number one concern among aging Americans and financial professionals. Since the Great Recession (2008 – 2013) retirement experts and academics have written extensively on this dilemma, now deemed to be a national emergency.
Add to the long list of research reports on this issue, a working paper from the Center for Retirement Research at Boston College entitled Homeownership, Social Insurance, and Old-Age Security in the United States and Europe, (October, 2017) by Stipica Mudrazija and Barbara A. Butrica. Clearly, the issue extends well beyond the United States.
One of the more important conclusions is the need to include housing wealth (home equity) as a key component to increase and extend retirement income. In fact, the working paper states, “If the housing equity of older Americans were completely monetized, median household income would increase by over a third – more than in countries like Sweden and Denmark, but well below countries like Spain and Italy.”
2019 A New Year and New Considerations for Senior Homeowners
Thanks to the tax law changes (which went into effect in 2018), including the increased standard deduction, the great majority of senior homeowners will no longer be itemizing deductions, and therefore unable to deduct mortgage interest as they have in the past. This calls to question – What is the best way for older homeowners to manage mortgage debt in retirement? One consideration is refinancing to a HUD/FHA insured HECM reverse mortgage.
Home Equity Conversion Mortgage (HECM) – provides unique planning options
HECM is the HUD/FHA insured reverse mortgage. It was developed specifically to enable senior homeowners (62 and older), who want to remain in their homes, the ability to convert or monetize a portion of their housing wealth to increase financial and retirement security.
In the past, HECMs were mistakenly viewed as a “loans of last resort”. Today, however, they are recognized as important financial planning tools, especially for retirement planning.
Compared to a traditional mortgage or home equity line of credit (HELOC), HECMs have unique terms favoring senior homeowners, including:
- No monthly payments required – prepayments are voluntary
- Credit line growth – the undrawn balance grows (compounds monthly) at same rate charged on borrowed funds
- No maturity date – loan repayment not due until no borrower resides in the property and the loan remains in good standing
- Final loan repayment amount can never exceed the property value at time of repayment – any deficiency is protected by FHA insurance.
- Non-Recourse loan – neither borrowers nor heirs incur personal liability.
- Funding amount established at closing – not affected if future property value declines
NEW STRATEGY – Refinance Current Mortgage to a HECM Reverse Mortgage
This strategy involves replacing current mortgage debt or liens with a HECM reverse mortgage. The purpose is to: (1) convert mandatory monthly payments to voluntary payments; (2) establish a guaranteed growing line of credit; and, (3) enable voluntary payments that will reduce the balance owed and increase the credit line for future needs. Example:
- Homeowner age 62
- Property value – $500,000
- Current mortgage balance – $100,000
- Monthly principal and interest payment – $1,000
- Objective – pay down mortgage balance as originally intended, plus establish a new stand-by line of credit
- Strategy: Refinance to a HECM reverse mortgage – ASSUMPTIONS:
- Property value increases 2% annually
- Interest rates continue at current level (4.98% interest + 0.5% FHA insurance = 5.48% total annual cost assessed monthly)
- Upfront costs – $18,000 (includes one-time FHA insurance premium –2% of $500,000 value = $10,000) included in new loan amount
- Terms: Annual ARM with 5% lifetime margin rate cap. No maturity date.
- Voluntary pre-payments – assumes the borrower will continue to make voluntary $1,000 monthly payments for 14 years then one $1,000 payment in year 15. Thereafter, no payments are made.
- This illustration demonstrates the original objective of reducing the loan balance as the current mortgage terms provide. However, the HECM creates a credit line wherein the undrawn balance is guaranteed to grow, compounding monthly, at the same rate charged on the loan balance. In fact, the credit line could potentially exceed the property value should real estate values decline as shown above.
- Although this illustration does not show withdrawals, simply to demonstrate growth potential, the funds are available at any time.
- The accompanying chart shows projection estimates in five year increments to demonstrate longer term potential.
TO LEARN MORE: Illustrations can be customized to demonstrate individual circumstances and what-if scenarios.
The example above was developed to demonstrate the potential a HECM might provide without any withdrawals along the way. More representative scenarios can be customized to simulate more likely scenarios for individuals based on their circumstances and expectations. These simulations may provide greater insight into the potential value a reverse mortgage may provide. On the other hand, it may show that a reverse mortgage may not provide the best choice.
For the most part, reverse mortgages have been an overlooked resource due to a variety of misunderstandings and misconceptions. While the program holds great potential for many, it is not a suitable solution for all. Thorough understanding of each individual’s needs and circumstances are essential before a reverse mortgage, or any other program to use housing wealth is employed.