Longevity Insurance…Smart use of home equity to “insure” retirement success
Fallout from the Great Recession (2007 – 2009) continues today as seniors are at increasing risk of outliving their financial resources. This recession devastated the savings of many seniors with market losses averaging 40% along with widespread declines in home values. As a result, reduced nest eggs are less able, or unable, to sustain financial support for life expectancies. This double whammy, along with the elimination of traditional pensions, compounds the longevity risk dilemma of running out of money.
In today’s environment, where increasing numbers are at heightened risk of outliving retirement savings, using home equity as a means of protecting against longevity risk cannot be overlooked. This is especially important today as home values have generally recovered since the Great Recession. In many areas property values have achieved new record highs. Essentially, there are two ways to capture increased value: (1) sell the home and downsize or rent, and (2) refinance with a traditional mortgage, Home Equity Line of Credit (HELOC), or a HUD/FHA insured Home Equity Conversion Mortgage (HECM) reverse mortgage. The great majority want to age in place at home.
To this end, the HECM reverse mortgage may provide the ideal solution. The HECM was developed by HUD/FHA and approved by Congress to enable senior homeowners, who want to remain in their homes, the ability to utilize home equity to increase financial security without selling or giving up title ownership.
In contrast to traditional mortgages or HELOCs, the HECM program was specifically designed for senior homeowners (62 or older) only, and contains unique features including: (1) optional payments – payments may be made, but are not required; (2) funds withdrawn do not affect Social Security or Medicare benefits, and are not subject to federal or state income tax; (3) no maturity date – loan repayment is not required until last borrower no longer resides in the property; and (4) a guaranteed line of credit that grows even if future property values decline.
Obviously, there is no insurance product available that could “insure” retirement success, but academics and retirement researchers are advocating new financial planning strategies uniting home equity with savings to extend financial security and reduce, or potentially eliminate, longevity risk. Among others, distinguished retirement expert, Wade Pfau, Ph.D., (Professor of Retirement Planning at American College and Retirement Research Director at McLean Asset Management) advocates – using home equity via the HECM reverse mortgage is one of the smartest risk management tools available for retirement planning.
One key element to this smart strategy is the HECM’s guaranteed and growing line of credit. Now dubbed a standby line of credit, this unique provision provides: (1) cash flow in down market periods to protect against cannibalizing assets under management; (2) additional liquidity for unanticipated needs or emergencies; (3) hedge against rising interest rates as the credit line growth rate increases/decreases simultaneously with interest rate changes; (4) unused credit line amount can grow to exceed the property value without personal liability to the borrowers or their heirs; and (5) cannot be cancelled or frozen by the lender as long as the loan remains in good standing. Good standing means borrowers are required to keep real estate taxes and property insurance obligations current; maintain the property; and, live in the property as their principal residence.
Clearly, running out of money, or being forced to reduce one’s standard of living, is a real and growing threat to aging seniors. The solution requires effective planning and action, which include: (1) early action and understanding the risk is real and manageable; (2) thorough assessment of individual needs and circumstances; and (3) developing and implementing a comprehensive plan tailored to individual needs that utilize all resources (including home equity) to achieve maximum results.