Excerpt from July 2019 Advisor Magazine Online
With the current retirement income crisis facing baby boomers, advisors need every viable resource to help their clients and sustain their practice. Reverse mortgages have become one such resource. Historically, the financial services community has either dismissed the reverse mortgage or relegated it to use as a last resort. However, much has changed in the last few years, including FINRA’s position on the program.
The most common type of reverse mortgage is Home Equity Conversion Mortgage (HECM). It is a federally insured loan for those age 62 or better that allows them to convert a portion of their primary residence’s value into tax-free dollars without the obligation of a monthly mortgage payment.
One of the ways reverse mortgage proceeds can be taken is through a line of credit. It is similar to a traditional bank line of credit, but has three significant differences:
- No Mandatory Monthly Payments – The HECM does NOT require any monthly loan payments on the money that is taken.
- Growth of the Line of Credit – The unused portion of the HECM has a built-in, guaranteed growth factor that allows it to grow regardless of the home’s value.
- Cannot Be Frozen, Canceled or Reduced – The HECM cannot be closed as long as the requirements of the loan are being met: live in the property, pay property related charges and maintain the home.
The chart shows the projected growth of the HECM line of credit for a 62-year-old with a $200,000, $400,000, and $600,000 home value.
The HECM line of credit is a foundational element on which three of the four underutilized reverse mortgages strategies in this article are built. Let’s take a look at the first strategy: the HECM Exchange.
1. Creating a Longevity Plan with the HECM Exchange Strategy
One of the most common uses of a reverse mortgage is to replace an existing loan (mortgage, HeLOC, etc.). The primary benefit of this strategy is the elimination of a mandatory monthly loan payment—oftentimes relieving cash flow pressure or allowing for the reallocation of the liberated dollars to accomplish other planning objectives.
However, some clients are comfortable making a monthly payment. When this is the case, a little-known strategy that can have a huge impact on retirement can be employed: establish a HECM and CONTINUE to make monthly loan payments. Let me give you an example of how this works.
Clients Age 65/65 | $400,000 Home Value | $100,000 Mortgage | $1,000/Month Payment for 13 years
For these clients, making a mortgage payment is not a hardship and they would like to be more prepared for unexpected expenses that may creep up in retirement. After doing some research, they choose a strategy that allows them to establish a reverse mortgage AND continue making monthly payments, except now they pay the reverse mortgage company instead of the forward mortgage company.
- The HECM makes $159,600 available.
- As a requirement of the loan, their existing mortgage balance of $100,000 is paid off in full, leaving them with a $59,600 growing line of credit.
- They continue making $1,000 monthly payments—accomplishing two key things. (1) Their outstanding loan balance decreases (Bottom Line). (2) Their available line of credit increases (Middle Line). The top line shows their appreciating homes value.
Notice the difference that making a voluntary monthly payment makes to their accessible line of credit. Best of all, they are able to accomplish this without any change to their financial behavior pattern.
2. Creating an Extended Care Plan with a HECM Line of Credit
The largest overlooked and under-planned expenses in retirement are health and long-term care. Recent studies show that the average 65-year-old, married couple can expect to spend in excess of $280,000 on healthcare. That figure doesn’t factor in extended care costs, which can average $130,000.
Planning for these costs is a momentous challenge, but reverse mortgages can help. In my recent book, The Retiree’s Guide to Housing Wealth www.housingwealthbook.com, I outline seven ways to structure a long-term care plan using Housing Wealth; three of those ways are included here.
Establish a growing reserve of dollars with a HECM line of credit and use those funds as needed to cover long-term care costs without having the burden of a mandatory monthly loan payment. If your clients have an existing mortgage and are financially comfortable making monthly loan payments, they can employ the HECM Exchange strategy we discussed above.
(B) Premium Replacement
Clients who have a current house payment can use the HECM to pay off the loan. Now the money that was going towards their loan payment each month can be reallocated to cover long-term strategies.
(C) Gap Funding
While your clients’ long-term care or life insurance should cover much of their cost of care, it may not cover everything. HECM monthly payments can help bridge the gap between what their insurance covers and what it does not. It can also fill in if they must leave their job early and need funding until their policy kicks in.
3. Creating New Savings with the HECM for Purchase
In 2008, as part of the Housing and Economic Recovery Act (HERA), HUD authorized the HECM for Purchase (H4P). This reverse mortgage allows retirees to purchase a new home with a 50-60% down payment and use the HECM to finance the remainder of the purchase price.
This simple strategy can help retired clients increase their cash flow, reduce their expenses, and add new money back into their retirement savings. Here’s how the H4P program works.
Step A: The clients sell their $535,000 home, pay the realtor/taxes, and have $500,000 left over.
Step B: They pay off their existing mortgage of $100,000.
Step C/D: They now have $400,000 left to put towards their next home. In this example, they choose to move to a less expensive home valued at $300,000, and though they could pay cash…
Step E: They choose the HECM for Purchase, which makes $126,000 available to them.
Step F: They must add $174,000 of their own funds as the down payment.
Step G: After using $174,000 of the proceeds from the sale of their old house, they have $226,000 left over to be added back into retirement savings.
Additionally, the clients have increased cash flow because they are no longer making a mandatory monthly mortgage payment. They have also reduced their expenses by moving into a newer, better built, more energy efficient home with fewer square feet.
4. Creating Tax-Free Income with a HECM Infused Roth Conversion
Although tax-free retirement income is very desirable, it’s not always achievable. Many retirees already know that converting a portion of their taxable savings to a tax-free Roth IRA is a great strategy. However, there’s often an obstacle that stands in their way: the amount of taxes owed on the converted amount.
A simple conversation to have is how the HECM proceeds can be used to pay the conversion taxes. Let say a client has a $450,000 home and $200,000 in an IRA that they want to convert. One option is that they could pay the taxes from the HECM—in a single lump sum or over several years from the HECM line of credit.
From the chart you will notice that by paying the taxes from the HECM over a longer period of time (10 years in this example), not only will they have access to the line of credit AFTER the conversion, they will have more in the line of credit than they started with because they have taken advantage of its growth factor.
Line of Credit Growth with Taxes Paid Over 10-Year Period
From the most common uses to the more complex, I hope it has become clearer that reverse mortgages can significantly contribute to retirement outcomes. And if advisors are to optimize their clients’ retirement income plans, they must consider all available assets and begin learning how to introduce Housing Wealth into the planning conversation.
Don Graves, RICP®, CLTC®, CSA is the president and founder of the Housing Wealth Institute, and architect of the Advisor’s Certificate Course in Housing Wealth www.HousingWealthCourse.com. He is a bestselling author of two books and an Adjunct Instructor of Retirement Income at the American College of Financial Services. He is considered one of the nation’s leading educators on incorporating Housing Wealth into retirement income planning. For more on Housing Wealth go to www.HousingWealth.net or email firstname.lastname@example.org