Inadequate savings and longer life expectancies collide and threaten retirement security.
According to the Boston College Center for Retirement Research analysist, Stephen A. Saas, home equity is the most underutilized asset in retirement financial planning. In an academic brief published in March 2017, Sass explains the foundational issues why it is not commonly used, and advises that downsizing and/or a reverse mortgage provide optimal solutions for making better use of home equity for retirement security. The brief’s key findings are:
- Home equity, the largest asset for most households entering retirement, and can be best used by downsizing or by taking out a reverse mortgage.
- Few households currently use either option due to: (a) behavioral and informational barriers; (b) preference to stay in one’s home; and, (c) high transaction costs.
- Behavioral and informational barriers are the primary causes that impede downsizing or using a reverse mortgage.
- An open question is whether more retirees will overcome those impediments and tap home equity in response to growing financial pressures.
Since the Great Recession (2007 – 2009) seniors were among the hardest hit averaging 40% loss of savings through market declines in addition to widespread reductions in home values. Moreover, since life expectancies have increased, smaller nest eggs increase the longevity risk of running out of money. Longevity risks are real, predictable, and affect great numbers. Future planning must recognize and take full advantage of all sources of wealth including home equity, which can no longer be overlooked.
Retirement wealth includes two categories: (1) financial wealth – assets minus liabilities, and (2) housing wealth – home value less outstanding mortgages and liens. However, relatively few seniors have included housing wealth in retirement financial planning. More puzzling, is that traditional financial advisors and financial planning protocols have given little to no consideration of this vital resource. Again, why? (the full document is available here)
The Home Equity Conversion Mortgage (HECM) is the HUD/FHA insured reverse mortgage, which constitutes over 95% of all reverse mortgage programs nationally. In Massachusetts, it is the only approved reverse mortgage. HECMs are designed for senior homeowners (62 or older) only, and provide unique features including:
- A guaranteed and growing line of credit, which can be used for any purpose
- Credit line not affected if future property value declines
- No effect on Social Security or Medicare benefits
- Withdrawals are not taxable as income
- Optional payments – none are required, but may be made in any amount, if desired
- No maturity date – loan repayment due only when no borrower resides in the property
- Non-recourse loan – neither borrowers or heirs have personal liability
- Loan can never be called, or the credit line cancelled, as long as it remains in good standing – property tax and insurance obligations are current, home is maintained, and at least one borrower lives in the home
- Loan repayment obligation can never exceed property value – any deficiency is covered by FHA insurance.
The research brief principally addresses the question of why home equity has not been a fundamental planning tool to increase financial security and lessen longevity risks. Not surprisingly, much of the resistance has less to do with understanding and deliberation, and considerably more to do with lack of knowledge, mistaken beliefs, and the preponderance of negative sentiment. On the other hand, some of the criticisms were deserved due to the abusive actions of some bad actors, earlier program pricing and design flaws, and insufficient consumer protections. In recent years, however, these issues have been mitigated by a series of regulatory and policy changes instituted by the government (HUD/FHA) and the National Association of Reverse Mortgage Lenders (NRMLA). More information read our Reverse Mortgage FAQ’s.
The Sass briefing concludes: Households entering retirement will increasingly need to tap their financial assets and home equity to maintain their living standards. While home equity has been the largest store of savings for most households, retirees have generally resisted using it as part of their everyday retirement plan. They typically tap home equity only in response to a late-life financial shock. Downsizing early in retirement could cut the household’s ongoing expenses and increase its financial resources. A reverse mortgage taken out early could also be used to increase on-going consumption. Alternatively, it could secure a rising line of credit for use down the road, allowing the household to draw down its financial savings more aggressively earlier in retirement. Strong behavioral and informational barriers, however, have impeded such uses of home equity that could improve retirees’ well-being. Whether future retirees will exercise these options remains to be seen. But the pressures to do so will be much greater than they have been in the past.
Clearly, consideration of home equity wealth in retirement planning should be fundamental. Whether downsizing, for those planning to relocate, or for those who want to remain in their home, a reverse mortgage is a remarkably versatile tool, and should not be overlooked.