Reverse mortgages have gained considerable attention in recent years for their strategic use in retirement planning. But while financial planners, academics and other professionals have recognized the newfangled use of home equity as part of a coordinated retirement income strategy, one of the largest organizations representing retired Americans isn’t entirely convinced.
Much of reverse mortgages’ growing financial planning popularity can be credited in part to research published within the last decade demonstrating how home equity can be an effective component within a retiree’s retirement income plan. Particularly, the research has shown that when taken as a line of credit early in retirement, a reverse mortgage can provide several advantages, including the elongation of a retiree’s portfolio spending horizon, as well as using home equity as a “buffer” against market volatility to mitigate sequence of returns risk.
While various researchers have delved into reverse mortgages and where they fit in the context of retirement planning, the consistent theme has emphasized a proactive use of the line of credit disbursement option as early as possible in retirement in order for the retiree to achieve optimal results.
This is mainly because the impact of sequence risk can have a damaging effect on the longevity of a retiree’s portfolio, especially if negative returns occur early on in retirement, when the portfolio is being drawn upon to meet spending needs.
AARP acknowledges the use of a reverse mortgage line of credit to reduce sequence risk in its Public Policies 2015-2016. The organization, however, appears far from accepting this particular strategy for retirement income planning.
A ‘perversion’ of the HECM program?
AARP and reverse mortgages have a complicated relationship. It’s easy to attribute the strained relations to lengthy litigation in recent years concerning non-borrowing spouses and foreclosure. But although non-borrowing spouse policies have since been corrected by the Department of Housing and Urban Development, AARP maintains that reverse mortgages should be used with caution, especially when used for retirement income planning.
“The idea is that if investment values fall, a borrower can use their reverse mortgage line of credit to obtain funds, while not depleting their investment account when asset prices were low,” AARP writes in its Public Policies 2015-2016 regarding reverse mortgages.
The inherent risk in this strategy, AARP notes, is that the asset price recovery must exceed the costs of the loan, which cannot be known in advance.
While there isn’t any restriction on borrowers to use their reverse mortgages in this manner, AARP implores HUD to ensure that the Home Equity Conversion Mortgage program remains true to its original mission: to provide older homeowners with access to their home equity during a time of “economic hardship caused by the increasing costs of meeting health, housing, and subsistence needs at a time of reduced income.”
“The use of reverse mortgages to hedge investment portfolios is a perversion of the original intent of the HECM Program, a misuse of FHA insurance, and puts the FHA insurance fund—and ultimately, U.S. taxpayers—at risk of paying for these activities in the event of a future housing market downturn,” AARP writes. “HUD should take steps to ensure that homeowners who need money have access to HECMs, but should prohibit the use of HECMs for portfolio hedging.”
One way AARP suggests HUD can accomplish this is by eliminating the line of credit growth feature on adjustable-rate HECMs. Because the credit line grows regardless of any changes in home value, AARP argues that if home prices fall, borrowers have access to an “ever increasing’ amount of funds, thereby exposing the FHA’s Mutual Mortgage Insurance Fund to increased risk.
It is possible the U.S. could see another housing market downturn in the future, but do these fears justify shutting down a viable retirement option that helps many seniors in the near-term? One of the foremost researchers of reverse mortgages for retirement income planning begs to differ.
A ‘thousands of dollars’ difference
The conventional wisdom of using home equity has been to access it once all other financial resources have been depleted, more or less. Retirement income experts have often dubbed this method one of the “worst strategies” for using home equity.
“AARP seems to misperceive the importance of seniors’ cash flow throughout retirement,” said Barry H. Sacks, J.D., Ph.D, a practicing tax attorney in San Francisco, Calif., and the pioneer of the strategy of coordinating draws from a securities portfolio—such as a 401(k) account—with draws from a reverse mortgage credit line. “They imply that the use of a reverse mortgage credit line to offset the portfolio’s sequence of returns risk is an abusive practice, instead of what it really is, which is a long-term protective measure for the portfolio.”
Sacks, along with his brother Stephen R. Sacks, Ph.D., professor emeritus of economics at the University of Connecticut, first published their research, “Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income,” in the February 2012 issue of the Journal of Financial Planning.
The research examines several strategies for using home equity, in the form of a reverse mortgage line of credit, to increase the safe maximum initial rate of retirement income withdrawals. In conclusion, Sacks and Sacks found that a retiree’s residual net worth after 30 years is about twice as likely to be greater when a reverse mortgage credit line is used actively in retirement, that is, drawing upon the credit line to maximize portfolio recovery after suffering negative investment returns, and drawing upon the reverse mortgage credit line first, until exhausted.
The economic difference between using a reverse mortgage in this coordinated way, as opposed to the way AARP suggests it should be used, is “basically several thousands of dollars per year” in sustained inflation-adjusted cash flow throughout a 30-year retirement, for millions of retirees and soon-to-be retirees, Sacks told RMD.
Sacks published the first analysis of his research in 2004, after which he delved deeper into the subject and then published the first direct article in 2012. Occasionally, Sacks has appeared at national reverse mortgage conferences over the years to discuss his research on the HECM line of credit coordinated strategy as well as tax strategies for using a reverse mortgage in estate planning.
Sacks’ reverse mortgage strategy was not the original intent of the HECM program, but he affirms that the line of credit, when used judiciously, can greatly improve the success of a retiree’s portfolio throughout the duration of a 30-year retirement.
Based on AARP’s public policies concerning reverse mortgages, Sacks wonders if the organization has even read his research on the subject, especially when considering the language used by the organization in reference to reverse mortgages.
To describe reverse mortgages as being used for “portfolio hedging,” as AARP does in its policies, inadvertently associates HECMs with hedge funds, Sacks suggests.
“AARP uses a very loaded term, portfolio hedging,’ to link the coordinated use of reverse mortgage credit lines to those reviled devils, the ‘hedge funds,’” he said. “They use that loaded term in complete disregard of the importance to retirees of sustained cash flow, with lowered risk of cash flow exhaustion in the longer term.”
A spokesperson from AARP did not return RMD’s requests for an interview to comment on its reverse mortgage policies.
The proof of the retirement research on reverse mortgages lies within the mathematics behind it. Carrying a Harvard law degree and a theoretical physics degree from the Massachusetts Institute of Technology, Sacks joked that mathematics is something he’s “pretty good at.”
Sacks admits that he has the pride of the inventor, regarding his coordinated strategy research on reverse mortgages, for which he has a genuine U.S. patent. But when it comes to the future use of reverse mortgages for retirement income planning, the fears of another housing market comparable to 2008 happening in the near future is not a likely event, he said, and therefore shouldn’t be the nail in the coffin for a retirement strategy that has the “relative certainty of helping millions, if not tens of millions, of people.”
“Seniors need their cash flow maintained. That is so fundamental when you get old,” Sacks said. “If AARP doesn’t understand this need for sustained cash flow, then they don’t understand retired people.”