About 60% of the homeowners reaching 62 today have outstanding mortgage balances, and most of them have limited financial assets. Such retirees, concerned (as most are) with having enough spendable funds during their retirement years, should take out a HECM reverse mortgage. This holds whether the HECM is used to pay off the existing mortgage or not. Yet less than 5% of them take a HECM, and those that do are more likely to use it to meet immediate needs rather than to strengthen their retirement.
Major reasons why HECMs are not being used to strengthen retirement plans include their complexity, the vast amounts of misinformation that pervades the literature, and a widespread marketing thrust that caters to the temptation faced by retirees to draw cash upfront to meet current needs. There is virtually no marketing addressed to the potential role of HECMs in retirement planning. This article is an attempt to begin that process.
Comparing Retirement Options
I illustrate the case for taking a HECM with a woman of 62 whose home is worth $500,000, has an existing mortgage balance of $200,000 on which she is paying $1051 a month at 3%, and $250,000 of financial assets earning a return of 6%. The table shows spendable funds during her retirement years on 4 options if she pays off the mortgage, and under 2 options if she doesn’t.
The principal conclusion is that this retiree will enjoy more spendable funds if she takes out a HECM. I have not found any plausible combination of retiree-based features in which this conclusion does not hold. Readers who might wish to check it can do so using the spreadsheet Should You Pay Off Your Mortgage at Retirement
The Best Option For Retirees
As shown in the table, the indebted retiree who wants the maximum spendable funds during retirement will take out a HECM credit line, pay off the mortgage, and purchase an annuity with deferred payments (I assume a 10-year deferment). With this option, the credit line and the retiree’s financial assets are allocated between the annuity amount and draws on the credit line such that the line is exhausted when the annuity kicks in. The spendable funds provided are markedly higher than on any of the other options, with or without mortgage payoff.
The Second-Best Option For Retirees
The second-best option is a HECM tenure payment which is similar to an annuity, but with some differences. The largest difference is that the annuity payment is about 40% larger. In addition, annuities continue until death whereas tenure payments cease if the house is sold or the retiree moves out of it permanently – to a nursing home, for example. Nonetheless, the second-best option has been selected by many retirees while to my knowledge the best option has not been selected by any.
Why the Best Option is Not Selected
While the HECM tenure payment option can be provided by any advisor authorized to provide HECMs, the HECM/annuity combination can be provided only by firms that can deliver both HECMs and annuities. This has been prevented by legal restrictions designed to protect borrowers from being exploited by collusive arrangements between HECM lenders and annuity providers. Section 255(n) of the National Housing Act prohibits HECM lenders from any association with parties that offer “any other financial or insurance activity.”
But this onerous provision contains an escape hatch: a system of safeguards or firewalls that ensure that HECM originators have no financial incentive to direct annuities to their borrowers, impose no requirements on borrowers to purchase annuities, and cannot collude to set prices. Until now, however, the escape hatch has not been used.
Barrier to the Development of an Escape Hatch
While HECM lenders and annuity providers would both gain from acquisition of the capacity to combine HECMs with annuities, developing safeguards that comply with the law would be difficult, if not impossible, for either. The problem is that a major purpose of the safeguards is to prevent collusion by lenders and insurers, and any system controlled by one of them would be prima facie suspect. Credible safeguards must be provided by a third party whose financial interest is in establishing and monitoring the safeguards.
The Escape Hatch Now Exists
A system developed by Mortgage Professor LLC (MP), following extensive consultation with counsel, meets all the requirements of Section 255(n), and more so. Here is how it works.
· Advisors are licensed mortgage brokers certified by MP as proficient in retirement plan analytics. They are termed “Reverse Mortgage Integrators” or RMIs.
· In developing a retirement plan, the RMI accesses two networks maintained by MP, covering HECM prices and annuity prices.
· The HECM prices used in the plan are those posted on the HECM price network by the lender selected by the RMI. The RMI cannot use a lender that is not on the network. Clients have access to the network, allowing them to check the competitiveness of their price.
· The annuity prices used in the plan are selected by the network as the best of those included in MP’s annuity price network. The RMI has no discretion in selecting the insurer and can change it only if the client requests it.
· Neither the lender or the RMI has any contact with the insurer, and no funds are transferred between them. RMIs are paid by the lender while MP is paid by the insurer.
At this writing, there are only a few RMIs but more will emerge in coming months as retirees and other financial advisors become aware of the potential.
The author is chairman of Mortgage Professor LLC, which developed the safe-guard system described here, and which would profit from its implementation.