Excerpts from Journal of Financial Planning
by Peter Neuwirth, FSA, FCA; Barry H. Sacks, J.D., Ph.D.; and Stephen R. Sacks, Ph.D.
Using home equity to enhance retirement income is an emerging topic in the financial planning profession. Research on strategies for tapping home equity to boost the sustainability of retirement income drawn from securities portfolios, such as 401(k) accounts or rollover IRAs, is quite recent. The concept was first introduced in the Journal of Financial Planning by Sacks and Sacks (2012) and Salter, Pfeiffer, and Evensky (2012), both of which focused on home equity accessed by reverse mortgage credit lines.
Home Equity and Retirement Savings
Although data on retirement savings and home equity have been amassed from a number of surveys, there is not much coherence among, nor coherence between, the datasets. Some datasets consolidate data from ages 55 to 64 and 65 to 74 while others focus on the age group 63 to 65. And data on retirement savings is often tracked separately from data on home equity, making it difficult to draw conclusions about the distributions of the combination of home equity and savings.1
Some attempts have been made to correlate and combine home equity and retirement savings data. For example, Tomlinson, Pfeiffer, and Salter (2016) showed retirement savings, home equity, and home values for married retirees ages 63 to 65 who had non-zero retirement savings (see Table 1).
If, as some economists project, the use of home equity for generating retirement income grows in prevalence in the coming years (e.g., Merton 2015; Guttentag 2017), this conjoint analysis of the total resources available to retirees will improve financial planners’ understanding of the true state of retirement readiness of the population who will be retiring in the next five to 10 years.
The HECM’s growing line of credit. Also important to the analysis is the growing line of credit. A majority of the roughly one million reverse mortgage loans currently outstanding are HECMs.6 A unique feature of HECMs is that when some or all of the loan proceeds are taken in the form of a line of credit, the amount available to be taken grows over time. After the credit line is established, the amount available to be taken grows at the same rate as the interest applicable to the amount that actually is taken. (See the appendix for details on the assumptions related to the interest rate on the line of credit.)
The amount available when a reverse mortgage is established depends upon the age of the borrower at that time and is greater for an older borrower than for a younger borrower. However, the increment as a function of age is substantially smaller than the increment that results from an early establishment followed by the increase resulting from the application of the interest rate.
The effect of the HECM’s interest-based increase in the amount available is important in enabling a retiree to have cash available throughout a 30-year retirement. Moreover, at this time, reverse mortgages other than HECMs are not available as credit lines. Therefore, the reverse mortgage credit line considered in this paper was the HECM credit line.
Another important aspect of the HECM is the non-recourse feature. Regardless of the duration through which the HECM credit line is in place (and growing), the Federal Housing Administration guarantees that the retiree (or his or her heirs) will never have to pay back more than the value of the home. For many retirees, this guarantee, when combined with the growing line of credit feature, may be significant.
The amount of credit line initially available is a function of the age of the borrower at the establishment of the credit line and the prevailing expected rate. In this analysis, the borrower was assumed to be 65 years old. The prevailing expected rate at the time of this writing (May 2017) meant that the amount initially available was approximately 54 percent of the home value (the Monte Carlo simulation program determined the amount available at later ages for the spreadsheets using Strategy No. 2).
Other than approximately $125 for a mandatory counseling session, there are no out-of-pocket costs for establishing or maintaining a reverse mortgage line of credit.
The non-recourse feature of the HECM is significant over the long term (20-plus years into retirement). As a result, establishing a HECM line of credit as early as possible can provide the almost-affluent retiree—particularly if he or she is house rich and cash poor—with a significantly higher retirement income than a later establishment of the credit line, while reducing the probability of exhausting his or her assets.
(Source: Journal of Financial Planning)