When Even Wealthy Homeowners Are Using Reverse Mortgages, The Question Is: Why Aren't You?
When even the so-called "mass affluents" and "downsizers" with significant retirement savings are using reverse mortgages themselves, the question really is: Why aren't you?
The headlines are stark when it comes to the retirement of Americans. One quarter of those 50 to 64 have not saved a penny, and 14 percent of those 65 and older are in the same predicament. Even among those older Americans who have saved for retirement, there's not a lot in their kitty. By any definition of the term, Americans are in the midst of a severe retirement savings crisis.
If you look at households with people ages 55 to 64 that even have an IRA or 401(k) or both and add the two together, the median plan balance is $120,000, according to the Center for Retirement Research at Boston College. If you do an optimal drawdown or buy an inflation-indexed annuity, $120,000 gives you about $400 a month.
That's already prompted many people to turn to reverse mortgages to help in their retirement. Under a reverse mortgage, homeowners 62 and older receive a loan backed by equity in their homes. The lender isn't repaid until the person is no longer living in the home. Homeowners can either get a lump sum in the beginning and draw out more later or have a line of credit from which to draw as needed.
The Great Recession, which caused home values to drop, led to a nosedive for the industry. There were more than 110,000 reverse mortgages issued in 2008 and 2009, according to the Center. Those numbers dropped to 60,000 by 2013, but are expected to bounce back in the coming years.
What could aid in the resurgence in the market in part is a new group of retirees that are expected to take out reverse mortgages in the future.
One is the group you wouldn't think of first. It's referred to as the "mass affluent" who have several hundred thousand dollars in retirement savings but will use a reverse mortgage to supplement their income in a down stock market.
The second group is homeowners who opt to sell their home and downsize into smaller ones and invest some of the proceeds while taking a reverse mortgage to keep from having a house payment.
MASS AFFLUENTThe first growing trend is to use reverse mortgages to enhance the cash flow for those deemed as mass affluent retirees by financial planners. 75 million baby boomers--10,000 of them a day reaching 65 for the next 15 years--will provide a boost to the reverse mortgage industry, experts say. Of the 75 million, somewhere between 10 million and 15 million are considered part of the mass affluent category.
"It's a very misleading term because they're not massively affluent. Rather, there's a mass of them and they're almost affluent," says Barry Sacks, a California tax attorney and author and nationally recognized expert on trends in reverse mortgages.
What it means is they have $750,000 to $2 million of net worth at retirement. They're not so wealthy that they're biggest concern is minimizing the estate tax when they die. They have too few assets to worry about that, a bigger concern for those with $5 million to $10 million and more of assets, Sacks says.
These are people who
typically have "almost enough money to live comfortably," according to
financial experts. Typically, it's in a 401(k) plan
or a rollover IRA, and typically, they have a home mostly paid off.
It's not uncommon for that group to have $750,000 to $1 million in a
401(k) and another $750,000 to a $1 million in home equity.
In what goes against a lot of the conventional wisdom the public has about reverse mortgages, Sacks says these are the people that are most likely helped by having a reverse mortgage.
"The point of how to use it is the most important thing," Sacks says. "If it's used as a last resort after all of the other assets are exhausted during retirement, that's the conventional wisdom. And it turns out to be wrong. The conventional wisdom for a long time has said if you have your home equity, keep it in reserve. If you need it when you've exhausted all of the other money, then you have it working for you."
What is wrong with that thinking, Sacks says, is it doesn't take into account the volatility of the securities portfolio of the 401(k) account or the IRA. With securities portfolios so volatile and going up and down over the years, drawing from them when it's down is a mistake, Sacks says. If the poorer returns occur in the early years of retirement, then portfolio is likely to be exhausted if it's drawn upon continuously, he says.
"Instead of doing that, you use the reverse mortgage credit line to fill in those troughs when the securities portfolio is down and don't draw upon the securities," Sacks says. "If you draw from a reverse mortgage credit line and allow the portfolio to recover, then there's a far better chance there will be money flowing through a 30-year retirement."
What the experts say is older Americans should have a financial planner help develop a strategy that combines income from a reverse mortgage with other assets in their securities portfolio.
"Rather than liquidating their stocks and investments in a down market, they take money out of a line of credit during those down years," says Shannon Hicks, president of Reverse Focus, and a consultant that provides training and technology for the reverse mortgage industry. "Once their portfolio starts to recover, they stop taking it out of their line of credit and resume taking it out of their portfolio. What a study has found is the likelihood of the borrowing being able to have their portfolio last the rest of their life increased dramatically. In some cases, it went from a 65 percent success rate up to a 90 percent rate."
Why will reverse mortgages be popular among this affluent group but not the super wealthy?
The financial planners and experts say the super wealthy don't need this. They can't benefit as much from it because they live at a higher level than a reverse mortgage is capable of filling in for them. The reason is that a reverse mortgage is limited because all you're allowed to draw from it is an amount based on your age and the value of your house up to a limit of $625,000. The wealthy have securities portfolios that are really much bigger than the $1 million, $1.25 million or $1.5 million that are typical of the mass affluent and homes worth much more.
What about those who aren't mass affluent?
"If you have a $50,000 kitty, and you retire, you're in very bad shape economically compared to the mass affluent," Sacks says. "A reverse mortgage can help a little bit, but not in the significant ways that we have written about."
If that group with little investment income does a reverse mortgage, they should be disciplined and not burn up the proceeds in the first few years, experts say. If that's not a good option and all they have left to live on is Social Security, then a second option is one that many older Americans can try--sell and downsize.
DOWNSIZERSThey can sell their house and downsize and get a much less expensive house and use the proceeds to help them in retirement. Under this reverse mortgage strategy, it's called HECM For Purchase. A HECM is the official term for a government-sponsored mortgage known as a Home Equity Conversion Mortgage.
Imagine a person has a nice house and it's all paid for and all they got to live on is Social Security. Let's say their house is worth $500,000, they could sell that house for $500,000 and get a new house for $300,000, Sacks says. It's going to be smaller and maybe not as nice, but it at least gives them some security, he says.
If they used a HECM For Purchase, for that $300,000 home, a reverse mortgage may pay for $100,000 of that $300,000, price along with $200,000 from the $500,000 in proceeds from the sale. Now, they have a total of $300,000 to work for them in all the years they're in retirement, he says.
If they follow the 4 percent rule for safe investing and drawing, they would draw about $12,000 a year, Sacks says. That means they can get an extra $1,000 a month that they can spend from this drawing securities portfolio. They have their house, not free and clear, but they don't have to pay any mortgage on it, he says.
"While you live in it, you don't have to service a reverse mortgage. They're really helped out," Sacks says. "Sure it has to be paid back after they die or move out of the house but, in the interim, they have an extra $1,000 every month inflation adjusted for the rest of their lives. Let's say a couple is getting $3,000 a month in Social Security, then a $1,000 a month from their investments that's a 33 percent increase. If you draw 4 percent, it's likely to last for 30 years. That's a pretty good deal for people who aren't in a position and don't have that great big 401(k) that is $800,000 to $1.2 million that mass affluent have."
Sacks and other experts say those strategies can be beneficial to retirees.
What has hurt people in the past when it comes to reverse mortgages is some don't have the discipline to dole it out slowly. They'll get a taste for that money and start to spend it too fast and not realize it has to last 25 to 30 years. That mindset has to change when people retire and no longer have a salary. It's important to have financial discipline to manage the flow of money, experts agree.
"What has given reverse mortgages a very bad name was that before people knew about using it as a financial planning tool, they grabbed the dough and consumed it, not thinking that they'll need the money 10 years from now," Sacks says. "They've gone five years, six years and seven years and have used it all up, and then they're stuck. They have no home equity and nothing else. It's very sad. It's not the fault of the reverse mortgage. It's the fault of a lack of any financial discipline and any realism."
Hicks says changes by the US Department of Housing and Urban Development will help with that problem. Rather than the borrower being able to take all of the money on day one, now they have restrictions where the borrower has access to take 60 percent of the loan in the first 12 months to discourage burning up all the cash.
These two options should help the industry grow, analysts say. Hicks says he wouldn't be surprised if reverse mortgages among the mass affluent make up 25 percent of the market in the future and says it's a great market to target.
Hicks says the industry is at a "historic crossroads." From 1989 until 2009, the reverse mortgage program remained relatively unchanged and the qualifications were quite simple. Whereas today, the industry is moving towards traditional underwriting and while narrowing the demographic of the individuals that may qualify for the program financially, he says.
"The general perception of reverse mortgages as a product of last resort is moving into one of more of a mainstream product," Hicks says. "Mine isn't a popular opinion in the reverse mortgage community. I started out as a reverse mortgage originator before I started this company with other partners. I think we shouldn't be lending to individuals who are going to be financially challenged even after a reverse mortgage to meet their ongoing obligations of paying property taxes and homeowners insurance."
Sacks says reverse mortgages aren't going anywhere and wouldn't be surprised if the one million reverse mortgages in existence today grows by at least 150 percent in the next 10 to 20 years. The reason is that he views it as a "wonderful vehicle" that's now beginning to be recognized for its value as a financial planning tool to those who are prudent, disciplined and responsible.
"Over time, I believe they'll be around for decades and come to be used more responsibly," Sacks says. "It's a very good tool if used properly but it has unfortunately acquired an underserved bad reputation because it wasn't used properly in its early years. It has taken time to overcome this bad reputation, but we'll get there."
Boomer demographic bodes well for the industry at large, Hicks says. Out of eligible homeowners, the industry has only penetrated two percent or less of the entire market.
"We're definitely in a growth industry, which seems like a strange thing to say because we're also in a contraction phase right now. Once we get things sorted out and the dust settles, then I think we'll start seeing explosive growth."
The question is what about the other 98 percent and why are they not onboard, he says. The problem is people want to eliminate a mortgage, Hicks says.
"We have a lot of market potential and it's just getting over that hurdle of public perception and bias to begin reaching these individuals," Hicks says. "I think making inroads into the financial planners will help us, but I do believe that even though more affluent seniors with money under management will use the product, I still think we'll always have those people who want to eliminate their mortgage payment."
There's a lot here to think about. What do you think?