An Overlooked Use For HECM Reverse Mortgages

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In a recent article, I described how the HECM program allows eligible homeowners to benefit from unusually large home price increases without incurring the risks associated with little or no appreciation. See reverse-mortgage-is-an-excellent-hedge-against-property-value-risk-especially-now. The bad news is that rate-of-return risk is a much greater risk for retirees than asset value risk. The good news is that the HECM program can be used to hedge against that risk as well.

Consider the case of a 64 year old male retiree with $500,000 of financial assets and $500,000 of equity in his home. The division of his financial assets is 25% in common stock and 75% in fixed-return assets. He wants to convert as many financial assets as possible into spendable money during his remaining years, but without the risk of running out if he stays too long. The model used to complete this challenge was developed by my colleague Alan Redstone.

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Step 1 is to use part of the retiree’s financial assets to purchase a deferred annuity — one that doesn’t start paying until after some period, called a “deferment period.” The balance of his assets is taken out monthly for spendable funds during that period. This is represented by the row of expendable funds in Chart 1, which assumes a moratorium period of 20 years, a rate of return on assets remaining after purchase of the annuity of 5.9%, and a 2% annual increase in both draw amounts. and annuity payments. The dotted part of the line represents asset draws while the solid line shows annuity payments.

Why 5.9% return on 20 year moratorium? This is the average rate of return on a 25%/75% portfolio over a large number of 20-year periods. Why 20 years? Because it results in more expendable funds compared to the 10- and 15-year deferment periods, as shown in Chart 2.

Step 2 of this approach is to factor in the risk that the rate of return will be less than the average return. For example, assuming the same 25%/75% portfolio, there is a 2% chance that the rate of return will be 3.60% or less over a 20-year period.

It’s not a lot, but we buy insurance to protect against low-probability risks.

If the retiree assumes a rate of return of 5.9% but a return of 3.6%, the amount of the draw will decrease over 20 years, or until the annuity begins, as shown at the top of Chart 3. Is. This can be prevented by using HECM. The line of credit, as a buffer, provides draw mounts that exactly match the draw reduction from financial assets. This is the bottom line on the chart.

The focus of this article on the disposable funds available to the retiree says nothing about the asset value, which may or may not be a concern for the retiree. This will be the subject of an upcoming article.

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