Editor’s note: This is the fifth in a six-part series. Read Part 1, Part 2, Part 3 and Part 4.
A major and potentially valuable feature of the Home Equity Conversion Mortgage (HECM) program is that it offers multiple options regarding how a senior can withdraw funds, as well as the flexibility to switch from one option to another as one’s circumstances change. This makes the HECM a potentially valuable component of a senior’s retirement plan.
However, most seniors are selecting an option to cash out the entire equity in their house at the outset, which eliminates other options (unless they later repay some of the money they withdrew), and may leave them with nothing to fall back on if they need help in later years.
The HECM options that can significantly strengthen a retirement plan are being used by very few. The seniors who could use these options advantageously, unlike many who select the all-cash option, are not driven by immediate financial pressures — their financial challenges lie ahead of them.
Most seniors are not aware of how HECMs could enhance their retirement, and they don’t hear about it in HECM advertisements. The industry is focused on the all-cash option, because it is easier to explain, easier to sell and much more profitable.
This article describes several ways that a HECM can enhance a retirement plan.
Supplement income with a tenure annuity
All reverse mortgage models before the HECM were designed to provide seniors with additional monthly income for as long as they lived in their house, and the HECM offers this option, called a tenure annuity. The monthly payment continues until the borrower dies or moves out permanently.
The 72-year-old senior referred to in an earlier article who could draw cash of about $255,000 on a house worth $400,000 could opt instead for a tenure annuity of $1,460 a month. Or she could take $730 a month, reserving a credit line of $128,000 for future use. The HECM program allows seniors to combine credit lines and annuities in any proportions.
A unique feature of the tenure annuity is that it can be modified at any time based on the home equity remaining at that point, for $20 paid to the servicer. For example, the senior who finds that the monthly tenure payment won’t be needed for a while can switch the unused equity to a credit line, which will grow in size from that point on. In the opposite case, the senior who needs a larger payment can switch to a term annuity. For another $20, those who switched can switch again.
Use a HECM credit line to offset pension termination
Millions of married couples are living partially on pensions paid to one of them, which will stop when that person dies. The drop in income of the surviving spouse could have a major impact on that person’s standard of living unless it is offset by another source of funds.
A HECM credit line designed to be used by the surviving spouse after the death of the pensioner could provide that offset. The earlier the credit line is established, the larger it will be when the need arises.
Use a term annuity to avoid running out of assets
Seniors who enter retirement with a block of financial assets that they intend to use up during their remaining life face the challenge of deciding how much of these assets they can draw down each year without running out of money while they are still alive. HECM term annuities help deal with this challenge by allowing the senior to delay the process of asset depletion. Term annuities can be three or four times as large as a tenure annuity because the payments don’t last as long.
If the payment on a 10-year annuity is adequate to meet the senior’s needs, for example, the senior’s assets can be allowed to grow for another 10 years before asset depletion begins. This substantially reduces the danger of running out.
Use a credit line to avoid running out of assets
More affluent retirees who have assets sufficient to carry them well past their expected life span may nevertheless feel uncomfortable about the possibility, however small, that they could run out if their life span is exceptionally long. A HECM credit line is the perfect insurance policy against that contingency because it grows over time and it costs a tiny fraction of what a life insurance policy offering the same cash draw would cost. In most cases, the line won’t be used and the senior’s equity in the house would go to his estate, but meanwhile he has peace of mind.
Note that a senior can combine a term annuity that defers the asset depletion period and a credit line that insures against the remaining small probability of running out of money if he is exceptionally long-lived.