New Thinking About Reverse Mortgages

Rising interest rates could make reverse-mortgage lines of credit more appealing to younger retirees.

A reverse mortgage is a type of loan taken against equity in a home, available to borrowers who are at least 62. It requires no monthly payments, with interest charges instead added to the loan balance and paid only after the homeowner sells or dies. The loan can be taken as a lump sum or as monthly income, or as a line of credit, with no interest charges on unused amounts.

Many homeowners wait until well beyond 62 to take a reverse mortgage, because generally the older the borrower is the more he or she will be qualified to borrow.

In recent years, though, more financial advisers have warmed up to the idea of homeowners taking a reverse-mortgage line of credit when they are as young as 62, as a way to boost their nest egg. The key to this strategy is that the credit line grows over time, by amounts tied to the course of interest rates, and the unused portion can be converted to a substantial monthly income years later. And today, with inflation and interest rates widely expected to rise, these credit lines could be particularly valuable.

“Now is an exceptionally good time to be considering adding a [reverse-mortgage] credit line to the retirement blueprint,” says Shelley Giordano, chair of the Funding Longevity Task Force at the American College of Financial Services. Interest rates are low, which increases the credit limit on reverse mortgages, she notes, and if rates rise over the life of the loan, that will add to the growth of the credit line. Since interest rates tend to rise alongside inflation, the growing line of credit would provide an inflation hedge, she says.

Running the numbers

“Research has shown that setting up a line of credit as soon as possible, age 62, in order to let it grow and only tapping into the line of credit when needed can substantially improve the long-term sustainability of a retirement-income portfolio, meaning you can make your money last longer,” says Jamie Hopkins, associate professor of taxation at the American College of Financial Services.

The strategy—called a standby reverse mortgage, or SRM, by some—has been pushed in financial journals by a number of academics, starting with a 2012 paper by Barry H. Sacks, a tax attorney in San Francisco, and his brother Stephen R. Sacks, a professor emeritus of economics at the University of Connecticut. They recommend drawing from the credit line when investments like stocks and bonds are down, so the homeowner enjoys a steady income and gives other investments time to recover, allowing them to last longer.

They said the strategy was successful in 1,000 Monte Carlo simulations, which run calculations over and over while varying key factors like interest rates and investment returns. Not only did it improve the borrower’s chances of enjoying steady income to an advanced age, it could also produce a larger income along the way, they reported.

Another proponent is Jack M. Guttentag, professor emeritus of finance at the Wharton School of the University of Pennsylvania, who provides information on mortgages on his education website, the Mortgage Professor. “It’s a can’t-miss deal,” so long as the borrower can resist plundering the credit line for nonessentials, he says.

Article by www.wsj.com