Reverse Mortgage Tenure Payments Improve Retirement Portfolio Success
Reverse mortgage tenure payments have been largely ignored, and little used, in recent years. Tenure payments are equal monthly payments made to the borrower by the lender over the life of the loan. Several studies published in the Journal of Financial Planning have examined the use of a reverse mortgage line of credit as a “Standby Line of Credit” as a part of a retirement planning strategy. These studies have shown improved retirement portfolio success rates for those plans that utilized the standby line of credit, and also advocated for acting as soon as possible to take advantage of current market conditions and the built in reverse mortgage line of credit growth rate.
The standby line of credit has become the default planning tool used by financial professional’s that consider a reverse mortgage as part of their client’s retirement planning. The most recent issue of The Journal of Retirement featured a paper that analyzes earlier research and provides a case study illustrating the potential value of the reverse mortgage tenure payments. In this case study the article compares the impact of several strategies that could be used to help a retired client whose cash flow is getting tight.
Analyzing the client’s current chances of portfolio success, the advisor discovers at her current withdrawal rate of 7.3% the portfolio has just a 49% chance of success in lasting through retirement. First, the woman’s financial advisor recommends trimming her spending, however, the client rejects the 15% cut needed to achieve the targeted 90% success rate. The advisor then suggests she consider paying off the current mortgage balance of $200,000 with an IRA withdrawal. Doing so, however, causes her success rate to drop to 33%, an indication that the portfolio needs the leverage from the traditional mortgage, the researchers note.
The advisor then informs the client that she is eligible for a reverse mortgage large enough to retire the traditional mortgage and have enough capacity left for either a $137,000 line of credit, or $823 monthly tenure payments. Using the line of credit strategy as an emergency fund that grows but is never tapped, the woman’s success rate jumps from 49% to 89%. And in her later plan years, her required minimum distributions force IRA withdrawals larger than what is needed for her expenses, and so the extra cash is invested in a side taxable account.
If the woman opts for the reverse mortgage tenure payments strategy, adding monthly tenure payments to her cash flow instead of holding the unused line of credit, researchers indicate that her Monte Carlo success rate rises to 100%, and the taxable side account builds up earlier and quickly. As a result, her spending is fully funded every year of the simulated lifetimes and there is a cushion for emergencies, should they arise.
“Electing reverse mortgage tenure monthly payments created the highest final net worth, with the untapped Reverse Mortgage Line of Credit a close second,” wrote Davison and Turner. “Either method provided significant improvements to both her lifetime spending and her estate if she lives into the second half of the plan.”
The impact of the reverse mortgage stems from various factors, researchers noted, including reducing the client’s initial withdrawal rate from 7.3% to 5.4% by refinancing the traditional mortgage.
“The reverse mortgage eliminated $323,310 of fixed mortgage payments in the 30-year plan (plus extra taxes attributed to withdrawing mortgage and tax payments from the IRA),” researchers wrote. “The reverse mortgage also provided increasing leverage for the portfolio throughout the plan, rather than decreasing leverage from her traditional amortizing mortgage.”
Additionally, smaller early withdrawals reduced sequence of return effects, whereas adding monthly income from the reverse mortgage via tenure payments helped further reduced the withdrawal rate.
“The client’s cash flow and net worth in later years were higher with the reverse mortgage than the traditional mortgage,” wrote Davison and Turner. “This happened despite the reverse mortgage having higher monthly finance charges than her traditional mortgage. Her home equity was consumed by the reverse mortgage, but her investment assets more than offset the home’s value.”
This example, researchers said, clearly illustrates the need to look beyond the home’s decreased value to the entire balance sheet to understand a reverse mortgage’s impact on well-funded or constrained clients with assets beyond their house.
To find out how reverse mortgage tenure payments or a line of credit might work for you, visit our Reverse Mortgage Calculator or call us today at 1-888-340-0305!