http://papers.ssrn.com/sol3/papers.cfm? ... id=2685816
Strategic use of a reverse mortgage can improve retirement outcomes. The benefits are non-linear in nature, as they relate to the synergies created by reducing sequence risk for portfolio withdrawals and to the non-recourse aspects of reverse mortgages that can potentially allow a client to spend more than the value of their home. This article explores six different methods for incorporating home equity into a retirement income plan through the use of a reverse mortgage. Generally, strategies which spend the home equity more quickly increase the overall risk for the retirement plan. More upside potential is generated by delaying the need to take distributions from investments, but more downside risk is created because the home equity is used quickly without necessarily being compensated by sufficiently high market returns. Meanwhile, opening the line of credit and that start of retirement and then delaying its use until the portfolio is depleted creates the most downside protection for the retirement income plan. This strategy allows the line of credit to grow longer, perhaps surpassing the home’s value before it is used, providing a bigger base to continue retirement spending after the portfolio is depleted. Use of tenure payments or one of the coordinated spending strategies can also be justified as providing a middle ground which balances the upside potential of using home equity first and the downside protection of using home equity last. A key theme is that there is great value for clients to open a reverse mortgage line of credit at the earliest possible age.
There are a number of available overviews about the HECM reverse mortgage program.
The government frequently modifies program rules, which does mean that anything written
before September 2013 will be describing conditions rather different from today. At that
time the government streamlined the program to offer a single HECM option, eliminating
what had previously been two options: the HECM Standard and HECM Saver. More
recently, new safeguards have been created to reduce the initial amount of available credit,
to protect non-borrowing spouses who are under 62 when a reverse mortgage begins, and to
provide financial assessments to assure that borrowers will be able to meet the requirements
for property taxes, insurance, and home maintain to keep the mortgage from foreclosing.
By his analysis, the "Use Home Equity Last" strategy wins by a long shot. Now, how many of you millionaires are convinced enough to open a reverse mortgage at age 62?Seven total retirement income strategies will be considered, six of which involve spending
from a HECM:
Ignore Home Equity: This is the only strategy which is not comparable with the
others, as it makes no use of the home equity. The strategy is only used to indicate a
baseline probability of plan success when home equity is not used.
Home Equity as Last Resort: This strategy represents the conventional wisdom
thinking regarding home equity. It is the only home equity strategy which delays
opening a line of credit with a reverse mortgage. The investment portfolio is spent
first. If and when the portfolio is depleted, a line of credit is opened with the reverse
mortgage and spending needs are then met with the line of credit until it is fully
used. The PLF is calculated using the current PLF table for the updated age and
simulated interest rate value at the future date, assuming the same underlying 3%
Use Home Equity First: This strategy opens the line of credit at the start of
retirement, and retirement spending is covered from the line of credit first until it is
fully used. This allows more time for the investment portfolio to grow before being
used for withdrawals after the line of credit is depleted.
Sacks and Sacks Coordination Strategy: This strategy opens the line of credit at
the start of retirement, and spending is taken from the line of credit, when available,
following any years in which the investment portfolio experienced a negative
market return. No efforts are made to repay the loan balance until the loan becomes
due at the end of retirement.
Texas Tech Coordination Strategy: This strategy is modified from the original
strategy described in Pfeiffer, Salter, and Evensky (2012) to remove the cash
reserve bucket. This strategy performs a capital needs analysis for the remaining
portfolio wealth required to sustain the spending strategy over a 41-year time
horizon. Spending is taken from the line of credit when possible, whenever the
remaining portfolio balance is less than 80% of the required wealth glidepath.
Whenever investment wealth rises above 80% of the glidepath value, any balance
on the reverse mortgage is repaid as much as possible without letting wealth fall
below the 80% threshold, in order to keep a lower loan balance over time and
provide more growth potential for the line of credit. The line of credit is opened at
the start of retirement.
Use Home Equity Last: This strategy differs from the “home equity as last resort”
strategy only in that the line of credit is opened at the start of retirement. It is
otherwise not used and left to grow until the investment portfolio is depleted.
Use Tenure Payment: This strategy opens the line of credit at the start of
retirement and uses the tenure payment strategy. With an initial home value of
$500,000, an expected rate of 5%, and an age 62 start, annual tenure payments from
the line of credit are $17,972. Any remaining spending needs are covered by the
investment portfolio when possible.