Buffer against market swings

Reverse mortgages allow borrowers to access a portion of their home  equity in a variety of payment options, including a lump sum, monthly  installments or through a line of credit. Of all the different options,  the line of credit strategy has been gaining considerable attention from  financial planners largely due to its unique “growth feature.”

Similar to a traditional Home Equity Line of Credit (HELOC), a  reverse mortgage line of credit accrues interest only on the amount that  is borrowed. An advantage of the reverse mortgage credit line, however,  is that borrowers are not required to make monthly payments to the  lender (although you must still pay your property taxes and insurance).  Unlike a traditional HELOC, a reverse mortgage line of credit cannot be  cancelled or frozen by the lender, enabling borrowers to draw on the  credit line as needed for as long as they live in the home. 

If taken early in retirement and left to “grow” for  several years, a reverse mortgage line of credit can serve as a buffer .  . . when they face market turmoil and negative returns.

If taken early in retirement and left to “grow” for several years, a  reverse mortgage line of credit can serve as a buffer that prevents  retirees from drawing on their investment portfolios in years when they  face market turmoil and negative returns.

Coordinating draws from a reverse mortgage line of credit reduces the  strain on investment portfolio withdrawals, writes Pfau, who published  an extensive research paper detailing the various strategies in which a  reverse mortgage can be used in retirement income planning.

“Retirees are more exposed to investment volatility because  volatility has a bigger impact on financial outcomes when taking  distributions from the portfolio as compared with when adding new funds  to the portfolio,” Pfau says. “Reverse mortgages provide a buffer asset  to sidestep the sequence risk by providing an alternative source of  spending after market declines.”

A reverse mortgage line of credit can also provide other potential benefits for borrowers if obtained early in retirement.

Maximizing your funds

The second potential benefit for opening a reverse mortgage early,  especially when interest rates are low, is that the principal limit a  borrower can draw from will continue to grow throughout retirement,  according to Pfau.

Most of the reverse mortgages found on the market today are insured  by the Federal Housing Administration. Known as Home Equity Conversion  Mortgages (HECMs), the government backing makes reverse mortgages  non-recourse loans. This means that if the reverse mortgage loan balance  grows to be larger than your home value, you will never be required to  pay more than the home is worth at the time of sale.

Because you will never be on the hook for more than your house is  worth, this non-recourse provision can benefit borrowers who end up  living longer lifetimes, granted they continue to live in the home as  their principal residence. Vacating the home for any reason for longer  than 12 months triggers the reverse mortgage to become due and payable. 

Borrowers may particularly benefit from the non-recourse provision if  they obtain a line of credit and manage to live long enough where the  balance in the credit line has grown to exceed the value of their home.

“. . . for sufficiently long retirements, there is a  reasonable possibility that the line of credit may grow to be larger  than the value of the home . . . .”