Is it time to reverse your thinking on reverse mortgages?

There are few terms in the finance industry more reviled in the minds of the general public, as “Reverse Mortgage”.  However, as is often the case in the world of finance, long-held perceptions and biases, are not always reflective of the financial reality of today’s economy, and, as a result, can be counter-productive. Regardless of what you think you know about reverse mortgages, and barring some new revolutionary change in the world of retirement income sources, these products will likely be an absolute must for many Americans in the coming years.  Therefore, it is a mistake for retirees and pre-retirees to shun such options, without doing some research. By gaining a deeper knowledge about how they work, they can determine if a reverse mortgage might have some value for them going forward.

Starting with the past…

To understand today’s environment, we first take a brief trip into the past.  Since the days of the homesteaders, the family-owned house has been the quintessential icon of security and prosperity in our nation. It was a tangible asset, that protected us from the elements, was a gathering and living place for our extended families, and said something about our social class in society.  Our home (or quite often, farm) was the place where several generations lived, worked, and cared for each other.  Wives and daughters often stayed in the home, and took care of parents and grandparents as they aged.  In this environment, the idea that the house could provide an income stream in retirement never even occurred to most of us.  We were able to live off what we produced or worked to earn, and we had enough family members at home to care for the elders when they could no longer work.  Also, life expectancies were so much shorter that, planning for a twenty, thirty or even forty-year retirement was completely unnecessary.

Presenting the present…

Today, things look very different.  Rarely do we see children living with aged parents or grandparents anymore.  Wives and daughters are not expected to stay home to care for the elders, but to become a part of the work force.  Homes are infrequently held for many generations, and, in fact, are sold on average every 5.9 years1.  In the past 100 years, life expectancies have increased by over 30 years2, and as a result, the need to acquire significantly more assets to fund these non-working years has become acute. At the same time, we now have less (or at least less reliable) income sources to provide this funding. Defined-benefit pensions have mostly gone the way of the Dodo.  We’re constantly told that Social Security is in serious trouble.  Bonds and CDs pay very little interest, and may experience significant drops in value when interest rates eventually start to climb back towards their historic norms.  All these factors have combined to make preparing for a lengthy retirement, harder and more frustrating than ever.

Reality check please…

For a great many people, the idea that their largest asset will just sit there throughout their thirty year retirement, doing nothing, other than providing shelter, (and a nice inheritance for their children once they’re gone) makes no financial sense at all.

Our home, no matter how much we may love it, is just another of our financial assets, and for many, far and away our largest.  Those fortunate enough to have other assets sufficient to see them through retirement, can choose to forego even considering a reverse mortgage (though, it still may make statistical sense in many cases, depending on how other assets are structured - more on that in a moment). However, for the rest, this may not be feasible, and a great many will find themselves facing a tough choice between significantly cutting their living expenses in their latter years, or finding an alternate source of income. With a reverse mortgage, they just might find the perfect solution by leveraging their home into that additional income stream they cannot outlive, all while being able to stay in their home as long as they are physically and mentally able. Because the industry is still basically in its infancy, and the structures of, and rules surrounding these types of mortgages will undoubtedly change quickly, it will be imperative, for consumers and financial advisors alike, to stay abreast of all the specifics as the industry evolves. The devil, as always, is in the details, and, as with any complex financial product, it is essential to perform thorough due diligence before making any decisions or recommendations.

Often overlooked…

Perhaps the most valuable, and often overlooked aspect of the reverse mortgage, at least for those that seemingly have saved enough for retirement, or perhaps are just on the edge, is its ability to help mitigate “sequence of return risk”. Sequence of return risk, is the risk to a portfolio’s longevity, that comes from having to take withdrawals when the portfolio is down significantly, especially in the early years of those scheduled withdrawals (i.e. the first years of retirement).  What a reverse mortgage does, is provide an available line of credit to pull from, that is fixed (growing, actually) and not subject to the short-term volatility of the stock/bond markets. Retirees, are therefore able to manage this “sequence of return risk”, by having an alternative funding source in the “bad years”, giving their investment portfolio the time it needs to recover, without having to access those investments at the wrong time. It is precisely the power of this potential retirement strategy that has some forward-thinking financial planners questioning why anyone who owns a home, shouldn’t open a reverse mortgage at or very early on in retirement, even if they never actually use it.

What it all means…

In a perfect world, after working for so many years, we would all have plenty of money for our retirement, and we would all be able to pass the family home on to the next generation without encumbrance.  But, of course, we do not live in a perfect world; we live in the real world, and we need to be pragmatic about the options available to us. Reverse mortgages are not for everyone, and are not a panacea for all of our financial shortcomings, but, in the right circumstances, they can truly be a god-send. It’s a nice bit of imagery really, if you think about it. Our home, which has provided shelter from so many storms throughout the years, in its last act of valor, once again provides shelter, this time from the erosion of our financial assets, allowing us to live out our golden years with dignity and independence.

 

1US Census Bureau:   http://quickfacts.census.gov/qfd/states/00000.html

2 Max Roser (2015) – ‘Life Expectancy’. Published online at OurWorldInData.org. Retrieved from: http://ourworldindata.org/data/population-growth-vital-statistics/life-e... [Online Resource]  http://ourworldindata.org/data/population-growth-vital-statistics/life-e...