The threat is real but solutions may be available to those who are serious about retirement security.
It’s no surprise, financial professionals have consistently reported – the number one concern among retirees and pre-retirees is fear of not having enough money to fund their retirement years.
Highlighting this reality, a Special Report from the Stanford Center on Longevity, Seeing Our Way to Financial Security in the Age of Increased Longevity (October, 2018), documented that increasing numbers of Americans are entering retirement with less savings and greater debt. Compared to previous generations, the prospects for continuing homeownership and financial security in retirement is changing – for the worse.
Among other conclusions, the findings illustrate that the majority of American workers from all backgrounds are not on a path to retire full time at age 65 under their pre-retirement standard of living. Consequently, they’ll need to consider alternative models of retirement, such as working longer, deferring Social Security, changing one’s standard of living in retirement, utilizing home equity, engaging new strategies for deploying retirement savings, or some combination of these models.
Clearly, the obvious answer is to start early, save more, and eliminate debt before retirement. More easily said than done. On the other hand, what can be done for those less well prepared? The question is challenging, but there may be answers for those willing to take the time and plan. Sounds difficult, and it may be, but avoiding the consequences is vital. The best approach is to engage competent professional help to lead you through the process, advise what must be done, and assist you with implementation of needed action.
To increase financial resources, one solution may be found in taking a new look at accumulated home equity, more recently recognized as “housing wealth”, and how it may be used more effectively.
Housing Wealth – an overlooked resource to increasing financial security
For the most part, traditional financial planning practices have excluded housing wealth in financial and retirement planning strategies. However, that is changing due to recent research and recommendations from reputable academics and retirement think-tanks – that housing wealth can and should be a fundamental consideration in financial and retirement planning. For many, it might be a game-changer to increasing and extending retirement security.
Home Equity Conversion Mortgage (HECM) – provides unique planning options
The HECM is the HUD/FHA insured reverse mortgage. It was developed to enable senior homeowners (62 and older), who want to remain in their homes, the ability to monetize a portion of their housing wealth to increase financial and retirement funding.
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 (swap) 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 plus establish a stand-by line of credit
- Strategy: Refinance to a HECM reverse mortgage – assumptions:
- Property value increases at 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)
- 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 a similar objective of reducing the loan balance as the current mortgage provides. 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.
Rising Interest Rates – Effect on HECM credit line and balance owed projections
The first example (above) assumes interest rates do not increase in the future – an unlikely assumption. This example illustrates what the results would be if rates began increasing 1% each year, reaching the 5% lifetime cap in the fifth year, and remaining constant thereafter at the capped limit. Essentially, this would portend to be a worst-case scenario.
Most importantly, however, notice the effect rising interest rates have on the credit line growth. Contractually, the credit line growth is driven by the rise (and fall) of the interest rate charged on the funds borrowed. Additionally:
- The credit line growth rate compounds monthly, thus accelerating the increases shown in below.Similarly, the balance owed will also increase at the higher rates.
- Borrower access to the credit line is guaranteed – even if the amount exceeds the property value as long as the loan remains in good standing.
- The credit line and the balance owed are separate accounts. As funds are withdrawn from the credit line, the loan balance increases by the same amount. Similarly, as voluntary pre-payments are made to reduce the loan balance, the credit line is increased by that amount.
TO LEARN MORE: Illustrations can be customized to individual circumstances and expectations.
The examples above were 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.