Two major retirement challenges could be addressed through a simple innovation. First, long-term investors are struggling to meet their (lowered) target rates of return. Attempts to raise returns by investing in riskier assets only raises the risk of future underperformance. Second, individuals have insufficient retirement savings and are facing the prospect of a meager retirement paycheck. A new real estate sub-asset class, iHomes (Income from Homes), created by innovative funds and real estate managers, could address these twin challenges with attractive results for all parties. The solution rests in allowing retirees to tap into home equity to generate income, and for innovative investors to get rewarded for supplying capital for these transactions.
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“The reverse mortgage market is evolving for the first time in a decade, as the industry pivots to address sagging sales and what it sees as a new opportunity presented by the number of baby boomers retiring.
Reverse mortgages are a type of loan that allows seniors to tap their home equity, as a lump sum or line of credit, without having to make out-of-pocket payments. The market has been dominated by a single product, a home equity conversion mortgage, which is insured by the federal government and sold by approved lenders. “
By Laurie Goodman and Edward Golding on May 31, 2019
The Home Equity Conversion Mortgage (HECM) program from the Federal Housing Administration (FHA) lets seniors tap into their $7 trillion in housing wealth to help them pay for living expenses that many have difficulty affording. But this program has proved very costly to the FHA, prompting the FHA to narrow the eligibility of the program, resulting in decreased participation.
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The Home Equity Conversion Mortgage (HECM) program is a unique hybrid of the public and private sectors, with a great deal of interest directed toward the Federal Housing Administration (FHA) and the Department of Housing and Urban Development (HUD) who set the policies by which that program operates.
by Peter Neuwirth, FSA, FCA; Barry H. Sacks, J.D., Ph.D.; and Stephen R. Sacks, Ph.D.
This paper examines the effect of using reverse mortgage credit lines to supplement retirement income by two types of retirees that have not been addressed in the previous literature: (1) those whose retirement savings are significantly below those of the mass affluent; and (2) those who are “house rich/cash poor.”
Results of this analysis demonstrate an important contrast with the results of the earlier literature; specifically, the greater percentages of home value, when coordinated with the retirement savings portfolio, resulted in substantially greater percentages of the portfolio that can be drawn.
This paper suggests a new alternative to the 4 percent rule that can guide planners and retirees toward an optimal cash withdrawal strategy. This new rule takes into account the total of the retiree’s retirement savings plus his or her home value.
The quantitative analysis in this paper uses the same spreadsheet models and strategies first presented in the Journal by Sacks and Sacks (2012). This paper builds on that work by extending the analysis to a broader range of retirees.
Maintaining higher fixed costs in retirement increases exposure to sequence risk by requiring a higher withdrawal rate from remaining assets. Drawing from a reverse mortgage has the potential to mitigate this aspect of sequence risk by reducing the need for portfolio withdrawals at inopportune times.
An HECM line of credit provides a tool that can be used to mitigate the impacts of sequence of returns risk. Since 2012, this has been the focus of a series of research articles highlighting how the strategic use of a reverse mortgage can either preserve greater overall legacy wealth for a given spending goal, or can otherwise sustain a higher spending amount for longer in retirement.
I have created a calculator that allows users to get a sense of the principal limit available with an HECM reverse mortgage on their home using the most popular one-month variable rate option. The calculator asks for eight boxed inputs, and uses these inputs to calculate the net principal limit. It also provides the amount of income that could be received as a tenure payment for those seeking this option. An optional ninth input also allows for a term payment amount to be calculated. I will describe tenure and term payments in detail later, but the calculator provides sufficient definitions for now.
One option in the broader category of using reverse mortgages for debt coordination for housing is the HECM for Purchase program, which was started in 2009 as a way to use a reverse mortgage to purchase a new home. The government saw enough people using a more costly and complicated two-step process—first obtaining a traditional mortgage to purchase the home and then using a reverse mortgage to pay off that mortgage—and sought to simplify the process and costs.