6 Strategic Uses of Home Equity in Retirement Income Planning – The Reverse Mortgage Conversation
by Howard Frankel, June 22, 2022
Over the past 5 years, I’ve seen the adoption curve for Advisors integrating a Home Equity Conversion Mortgage (HECM) into a client’s retirement income plan slowly rise. Some of this increase is client driven, where the consumer has become more educated on the changes to these loan products and the availability of newer 3rd party reverse mortgages that have unique features and much lower closing costs. I bet you didn’t know that you can now get a reverse mortgage starting at age 55.
So why is the adoption cycle taking so long, when there are Advisors who are staunch supporters in particular use cases? Well, based on my experience, some advisors haven’t been properly educated to have the reverse mortgage discussion with Clients and feel ill prepared to discuss the multitude of uses and where it’s a good fit vs. a bad fit. Perhaps some advisors are gun shy to bring up what was once a maligned topic and seek to avoid a confrontational situational. Are they worried that the mention of a reverse mortgage will somehow be perceived as a failure in their financial planning services? In the past, many Advisors shied away from the long-term care insurance conversation because their Client pushed back at the premium expense or wouldn’t accept that they might have a need for it down the road. Sometimes difficult conversations are avoided. Perhaps the reverse mortgage adoption issue is a result of the mortgage industry, where loan officers themselves fail to understand the detailed use cases and how to educate the Advisor community.
As an Advisor, there’s no doubt that you are constantly challenged when clients:
- Spend too much in retirement and exceed your recommended portfolio withdrawal rate.
- Request a large unplanned withdrawal(s) that triggers a tax consequence, often in a down market.
- Have too much equity tied up in their home(s), yet not enough in their portfolio to generate sufficient income.
In this article, I share 6 creative ways Advisors are using home equity as an integrated component of their Clients’ retirement income plan. And specifically, how a HECM or a jumbo reverse mortgage can be used strategically.
Lack of Long-Term care Insurance
Issue: Client has significant financial exposure due to a lack of (or inadequate) long-term care insurance. Client can’t qualify for coverage and/or can’t afford the premium payments.
Strategy: Establish a HECM Line of Credit as a funding source for future home custodial care. If Client has an existing LTC policy where premium increases have become excessive, consider using the HECM Line of Credit to pay these annual premiums to ensure coverage remains in force.
Benefit: Can help avoid portfolio drawdown and unnecessary tax consequences. A $350k HECM Line of Credit established today would grow to over $550k in 10 years at 5%.
Excessive Portfolio Drawdowns (Monte Carlo issues)
Issue: Client is exceeding your recommended monthly drawdowns, jeopardizing the portfolio’s longevity.
Strategy: Establish a HECM Line of Credit that will provide your client with a supplemental monthly payment to their current income.
Benefit: Reduce portfolio drawdown helping ensure financial longevity.
Substantial Home Equity but Lacks Liquidity
Issue: Home appreciation has created significant paper wealth that your Client can only access if they sell the home or take out a HELOC, requiring monthly payments.
Strategy: Establish a HECM Line of Credit or a jumbo reverse mortgage, freeing up cash flow for other spending needs. Uses could include home improvements to age-in-place, funding source for a 2nd home, etc.
Benefit: Unlocks trapped home equity, provides the Client liquidity, and may help avoid portfolio drawdowns.
Impact of 2nd Home Purchase on Portfolio & Cash Flow
Issue: Client has substantial equity in their primary home, but not enough cash for the 2nd home they want. Advisor doesn’t recommend liquidating portfolio holdings and triggering a tax event and Client’s cash flow can’t support an additional mortgage payment.
Strategy: “Transfer the equity” with a HECM on the Client’s primary residence. The Client can use the loan proceeds to purchase a 2nd home.
Benefit: Avoids portfolio liquidation and Client doesn’t have an added monthly mortgage payment. Puts Client in the position of being a “cash buyer”.
Issue: Client wants to establish legacy goals for their family while they’re still alive, but portfolio withdrawals or use of retirement income would negatively impact the portfolio’s longevity.
Strategy: Establish HECM Line of Credit, leveraging home equity instead of portfolio assets to achieve legacy goals such as gifting, charitable contributions, education, etc.
Benefit: Client gets to achieve their legacy wishes while alive and avoids excessive portfolio drawdowns and their tax consequences.
Issue: Splitting assets often forces the sale of the family home and limits the replacement home purchasing power of each spouse.
Strategy: If Spouse 1 wants to stay in the house, they establish a HECM, using the proceeds to buy out Spouse 2. Spouse 2 can now use those proceeds and their own HECM to purchase a comparable home.
Benefit: Spouse 1 gets to stay in the home without having to liquidate any part of their portfolio to buy out Spouse 2. Portfolio doesn’t get touched and tax consequences are avoided (other than the division of assets).
- Identify Clients that are 55 and older where a Monte Carlo analysis suggests a portfolio longevity issue.
- Talk to an experienced reverse mortgage loan officer who can educate you on the various strategies and their advantages and disadvantages.
- When appropriate, include this loan officer when discussing how to leverage home equity in retirement income planning with your clients.
- Incorporate the use of home equity in all Monte Carlo type analyses. Show your clients the before and after of incorporating the strategic use of home equity and how it impacts portfolio longevity.