As home equity conversion mortgages, also known as reverse mortgages, have grown in popularity in recent years, financial advisors have been employing them as risk- and cash-management tools. New government policy changes, however, may put a crimp in these strategies.
The Department of Health and Urban Development describes the HECM as "FHA's reverse mortgage program that enables you to withdraw a portion of your home's equity." It is for homeowners age 62 or older.
In 2010, HUD introduced an HECM option that dropped the large upfront costs of the products, which in turn made them more attractive to use proactively, said John Salter, professor of personal financial planning at Texas Tech University and partner with Evensky & Katz Wealth Management. The HECM is his research specialty.
New changes announced by HUD in August and enacted Oct. 2 may make HECMs less attractive, however:
- Upfront costs are raised to 2 percent of the home's value, up from 0.5 percent. According to Salter, lenders won't be likely to subsidize this much.
- The principal limit factor (loan-to-value ratio) is lowered, meaning less credit is available.
- The 1.25 percent fee is now lowered to 0.5 percent. This interest-rate reduction, in turn, lowers ongoing payments; however, it causes the borrower's line of credit to grow more slowly over time, according to Salter.
Portfolio strategies
Advisors have used reverse mortgages in various ways for portfolio management.
Cash management. "I've been recommending 'protective' reverse mortgages for clients who are over 62 and have no mortgages, or very small mortgages," said certified financial planner Mark Wilson, president of Mile Wealth Management. "These can provide a line of credit that's available if ever needed.
Setting one up early makes sense because the credit limit will rise over time; if not set up early, the credit amount will also rise, but not as quickly," he added.
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Reverse mortgages fundamentally provide access to a solidly growing amount of cash, said Tom Davison, Ph.D., CFP, researcher and member of the Funding Longevity Task Force of the American College.
"One intuitive method is coordinating draws from investment portfolios and reverse mortgages," he said. "Particularly in the first seven to 10 years of living on a portfolio, avoiding drawing from it in down years can be a big boost to sustaining the portfolio through the rest of your life."
Long-term care funding. Sally Long, CFP, principal and wealth manager with Modera Wealth Management, said that an HECM could be a way to fund long-term care expenses for clients who may not qualify for long-term care coverage.
"What I find compelling about the HECM for this need is the growth in the line availability along with the feature that doesn't require payments of advances but the ability to do so exists," she said.
Reverse mortgage basics
A reverse mortgage, also known as an HECM, for homeowners age 62 or older, must be the only mortgage on the primary home. It can be used to purchase a primary residence. The younger you are, the less you get, because there's more time for the loan to compound, said John Salter, professor of personal finance at Texas Tech University. For example, if you have a $100,000 line of credit, you are getting the same amount whether you are 62 or 82.
There are three ways to get money from an HECM (as a percentage of the house value and according to your age):
• Line of credit.
• Annuitized regular payments.
• Lump sum.
Using an HECM in this way also eliminates some complex steps with long-term care insurance, such as the initial application, underwriting and final approval for coverage, Long said. It also eliminates the cash flow impact of premium payments and potential premium increases.
Delaying Social Security. Another portfolio strategy is to use funds generated from a reverse mortgage to cover life expenses, and thereby delay filing for Social Security benefits. This approach has, however, come under criticism recently from the Consumer Financial Protection Bureau.
Recent concerns
In August the CFPB issued a brief warning against taking out a reverse mortgage to maximize Social Security benefits. According to the report, the costs of a reverse mortgage can exceed the lifetime benefit of waiting to claim Social Security and decreased home equity limits options to handle future financial needs. Additionally, homeowners wishing to sell their homes after taking out a reverse mortgage are "particularly at risk because the loan balance is likely to grow faster than their home values will appreciate."
In response, Davison of the American College said he finds the report to be misleading.
"What they don't understand is Social Security," he said. "I frame the Social Security delay strategy primarily as a risk-reduction step, and secondarily as income maximization.
"Roughly speaking, if you live to life expectancy, Social Security deferral may be about a break-even," Davison added. "But what if you are among the nearly half the people who live longer than 'expected'?" Anyone not sure they have enough money to live to, say, 95, should consider deferring Social Security, he said.
Furthermore, Davison added, the brief assumes the highest possible upfront loan costs and does not reflect the fact that a number of lenders offer credits to reduce the initial costs from what FHA allows.
— By Deborah Nason, special to CNBC.com
