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.
Now that we understand how reverse mortgages work, we can go into greater depth on the potential ways an HECM reverse mortgage can be used within a retirement income plan. For now, I want to focus on the big picture categories.
by Shaun Pfeiffer, Ph.D.; John Salter, Ph.D., CFP®, AIFA®; and Harold Evensky, CFP®, AIF®
This study investigates maximum real sustainable withdrawal rates (SWRs) for retirement plans that incorporate the use of standby reverse mortgages (SRMs). The SWR is defined as the maximum real withdrawal rate with a minimum 90 percent plan survival rate for a 30-year retirement horizon.
The SRM evaluated in this study is a Home Equity Conversion Mortgage (HECM) reverse mortgage line of credit that is established at the beginning of retirement and is used for retirement income during bear markets. Outstanding loan balances are repaid from the Investment Portfolio (IP) in bull markets.
Monte Carlo simulations were used to estimate the success of the SRM strategy at various real withdrawal rates for a client who has a $500,000 investment nest egg and $250,000/$500,000 in home equity at the beginning of retirement. The $500,000 nest egg is split into a 60 percent stocks and 40 percent bonds IP and a six-month cash reserve.
Retirees who begin retirement in a low interest rate environment (2.3 percent yield on 10-year U.S. Treasury bond) with competitive lending terms and significant home equity relative to the IP stand to benefit the most from an SRM strategy. Interest rates and the size of the initial line of credit relative to the IP are the two factors that are shown to have a significant impact on the SWR for the SRM distribution strategy.