Strategies for Using a Reverse Mortgage in Your Retirement Plan
Did you know that a reverse mortgage could potentially be a valuable part of your overall retirement plan? While reverse mortgages may not work for everyone, many senior homeowners can benefit from the program, particularly when it comes to incorporating their home equity into their retirement.
There are a number of ways to incorporate a reverse mortgage (also known as a Home Equity Conversion Mortgage/HECM). A 2015 study published by Wade Pfau, professor of retirement income at the American College of Financial Services, actually pinpointed six major strategies for using a reverse mortgage in retirement, and evaluated how each strategy impacted the homeowner’s spending and wealth.
While Pfau’s study is pretty in-depth, we will present a summarized version below. If you’d like to view the entire study, click here.
Six Strategies for Using a Reverse Mortgage in Retirement
1. Using home equity as a last resort.
Conventional wisdom generally regards home equity as something that should be left alone and only used as a last resort. Instead, the investment portfolio/retirement funds are spent first. If/when the investment portfolio is exhausted, a reverse mortgage is then opened. Funds from the reverse mortgage can be used to pay for whatever the homeowner needs, from living expenses to medical bills, to paying off debt or anything else.
2. Using home equity first.
This strategy involves using a reverse mortgage at the beginning of retirement, allowing the investment portfolio more time to grow before being used. Homeowners who take out a reverse mortgage first can use the funds however they like, perhps to pay their living expenses, while their retirement accounts are left alone and (hopefully) continue to increase. Then, later on, if the homeowner wishes to, they can draw their retirement and further supplement their income.
3. Sacks and Sacks Coordination Strategy
This strategy involves opening a home equity conversion mortgage (HECM) line of credit at the start of retirement, but only drawing funds from it following years when the investment portfolio experiences a negative market return.
4. Texas Tech Coordination Strategy
This strategy is a little more complicated. It involves opening a HECM line of credit in the beginning of retirement, then performing a “capital needs analysis” to determine how much money will need to be in the homeowner’s retirement account to sustain their spending stratgey. Once the analysis is complete and the threshold is determined (also referred to as the wealth glidepath), the homeowner draws money from the HECM line of credit when possible, whenever the remaining portfolio balance is less than 80% of that threshold.
When the retirement account rises above 80% of the projected glidepath value, any balance on the reverse mortgage is repaid as much as possible without letting wealth fall below the 80% threshold. This allows the homeowner to keep a lower loan balance over time and provide more growth potential for the line of credit.
5. Using home equity last.
This is similar to the “home equity as a last resort” strategy, except with this strategy, the line of credit is opened at the beginning of retirement. The homeowner still avoids using the funds and uses his/her investment portfolio instead. Once the investment portfolio is depleted, the homeowner then uses the HECM line of credit.
6. Using tenure payment.
This strategy involves opening the line of credit at the beginning of retirement and using the tenure payment options to receive funds. In a reverse mortgage, tenure payments are payments to the borrower that continue for as long as the borrower resides in the home, regardless of how long that is. If the homeowner needs additional funds to help cover their expenses, the investment portfolio is used when possible.
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So which strategy is best?
According to the study, the results showed that the strategy with the highest probability of success were the ones that involved opening the line of credit early but then delaying its use for as long as possible.
“The basic understanding derived from Figure 1 is that strategies which open the line of credit early, but then which delay its use for as long as possible will offer increasing success rates as more line of credit is available to be drawn from if and when it is eventually needed,” the study’s report states. “This benefit from delay is sufficient to counteract the reduced sequence risk created by using the line of credit in a more coordinated way over time.”
That being said, it’s fair to say that some strategies may work better for some borrowers than others. It’s up to you to determine (with the help of a qualified mortgage expert and/or financial planner) which strategy will offer you the highest rate of success in achieving your retirement goals.