Reverse Mortgages Gaining New Respect Among Financial Planners
Columnist Scott Burns: ‘Their time has come” – referring to home equity loans for senior citizens
June 1, 2012 - The
reverse mortgage has gained new respectability – well-known newspaper columnist Scott Burns, a highly respected guru on financial matters
concerning senior citizens, has just released an article with the title, “Reverse Mortgages: Their Time Has Come.” And, he refers to another
new article in the Journal of Financial Planning, “Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement
Both articles elevate the idea of senior citizens using equity in their homes as part of their financial planning in
What is called a reverse mortgage is technically a Home Equity Conversion Mortgage (HECM), the U.S. Department of Housing
and Urban Development program that was designed for senior citizens in 1987.
Consumer Reports explains, “Reverse mortgages let homeowners at least 62 years old use their home equity to take out a payment-free loan.
The lending bank does not pay the homeowner based on income, but rather on age, property value, and loan interest rate. Generally, the older
you are, the higher the value of your home, and the lower the interest rate, the more money you can borrow. The bank gets its money back when
you die or permanently move out and the home can be sold.”
But these unusual lending products have not been popular with everyone. Last year the two biggest banks making the loans,
Wells Fargo and Bank of America, pulled out of the of the market. The two had been providing over 40 percent of these loans in the U.S. Most
analysts say the banks were struggling with seniors not paying the taxes and insurance on their homes and could not deal with calling in the
loans of these elderly borrowers.
But, columnist Burns and others see brighter days ahead.
Burns writes in
AssetBuilder.com, “Reverse Mortgages are the Rodney Dangerfield of financial planning tools. Long thought of as things retirees used in
last-ditch efforts to stay in their house, they were seen more as leaky lifeboats than as financial planning tools. They were badges for
people soon to be broke.
“I should confess that I shared that view. Based on reader mail, reverse mortgages were great examples of
too-little-too-late. The vast majority of the people who wrote in asking about reverse mortgages really needed to rethink where they lived,
not draw down what was usually their last asset.
“But all that may be changing.”
This article in the
journal by Barry H. Sacks, J.D., Ph.D., and Stephen R. Sacks, Ph.D., examines three strategies for using home equity, in the form of a
reverse mortgage credit line, to increase the safe maximum initial rate of retirement income withdrawals.
These strategies are:
(1) the conventional, passive strategy of using the reverse mortgage as a last resort after exhausting the securities portfolio; and two
(2) a coordinated strategy under which the credit line is drawn upon according to an algorithm designed to maximize
portfolio recovery after negative investment returns, and
(3) drawing upon the reverse mortgage credit line first, until exhausted.
The cash flow survival probability over 30 years is determined for each strategy, and the comparisons are presented
graphically for a range of initial withdrawal rates.
Among their conclusions:
“We find substantial increases in the cash flow survival probability when the active strategies are used as compared with
the results when the conventional strategy is used.
“For example, the 30-year cash flow survival probability for an initial withdrawal rate of 6 percent is only 55 percent
when the conventional strategy is used, but is close to 90 percent when the coordinated strategy is used.
“The model also shows that the retiree’s residual net worth (portfolio plus home equity) after 30 years is about twice as
likely to be greater when an active strategy is used than when the conventional strategy is used.”
Barry H. Sacks, J.D., Ph.D., is a practicing tax attorney in San Francisco, California. He has specialized in
pension-related legal matters since 1973 and has published numerous articles in legal journals.
Stephen R. Sacks, Ph.D., is professor emeritus of economics at the University of Connecticut. He maintains an economics
consulting practice in New York and has published articles on operations research.
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