Tom Kelly: Reverse mortgage not just a ‘last resort’

The number of Americans over 65 who continue to work
has risen in the past decade. The unexpected rise can be
traced to a variety of factors including shell-shocked
retirement accounts, falling interest rates on savings
tools, fewer company pension plans, and the inability to
save.

Many of these people have raced to take part-time
employment, and baseball spring-training facilities are
prime examples. There were seniors selling tickets,
programs, hot dogs, popcorn plus acting as ushers and
parking lot directors in nearly all of the recently
completed Cactus and Grapefruit league games.

The goal of this age cohort is to supplement their
Social Security payments and portfolio securities (401k,
Individual Retirement accounts) so that they won’t run out
of money before they die. What other sources might be
available?

Barry H. Sachs, a real estate tax attorney in San
Francisco, and Stephen R. Sachs, professor emeritus in
Economics at the University of Connecticut, researched
ways to further enhance a senior’s finances by adding home
equity via a reverse mortgage. In a recently published
study, the authors found that a reverse mortgage can be
powerful tool when used within a coordinated strategy
rather than a “last resort” after exhausting the
securities portfolio.

The model shows that the retiree’s residual net worth
(portfolio plus home equity) after 30 years is about twice
as likely to be greater when an active strategy is used
than when a conventional strategy is used.

“It’s so important that financial planners have begun
to ask the question about what’s possible with reverse
mortgages,” said Martin J. Taylor, president of Bellevue-
based Stay In-Home, a reverse mortgage lender. “While they
have often been known for solving desperate situations,
they have a variety of uses in long-term financial
planning.”

What Sachs and Sachs have done is to compare three
strategies for the use of home equity via a reverse
mortgage to increase the safe maximum initial rate of
retirement income withdrawals. The commonly accepted
“safemax” begins with a first year’s withdrawal equal to
4-4.25 of the initial portfolio value. Subsequent years’
withdrawals then continue at the same dollar amount each
year, adjusted only for inflation. Since many retirees
have found the safemax uncomfortably limiting, Sachs and
Sachs calculated greater percentages in some examples.

The strategies:

(1) The conventional, passive strategy of using the
reverse mortgage as a last resort after exhausting the
securities portfolio.

(2) A coordinated strategy under which the credit line
is drawn upon according to a formula designed to maximize
portfolio recovery after negative investment returns.

(3) Drawing upon the reverse mortgage credit line
first, until exhausted.
The authors found “substantial increases” in the cash flow
survival probability when the active strategies are used
as compared with the results when the conventional
strategy is used. For example, the 30-year cash flow
survival probability for an initial withdrawal rate of 6
percent is only 55 percent when the conventional strategy
is used, but is close to 90 percent when the coordinated
strategy is used.

So, how is the reverse mortgage best blended together
with other investments? In a nutshell, it’s a basic
algorithm:

At the end of each year, the investment performance of
the account during that year is determined. If the
performance was positive, the next year’s income
withdrawal is from the account. If the performance was
negative, the next year’s income withdrawal is from the
reverse mortgage credit line.

According to the study, this spares the account any
drain when it is down because of its investment
performance. It also leaves the account more assets to
recover in subsequent up years. This is done in the early
years of retirement, so the account grows before the
reverse mortgage credit line is exhausted.

The authors emphasize that a reverse mortgage is not
necessarily a useful vehicle for every retiree who has
substantial home equity. A retiree whose primary source of
retirement income is a securities portfolio and who also
has substantial home equity must decide early in
retirement whether to live within the safemax limit set by
his or her portfolio. This decision is a fundamental
component of overall retirement planning.

Tom Kelly’s new E-book “Bargains Beyond the Border: Get Past the
Blood and Drugs: Mexico’s Lower Cost of Living Can Avert a
Tearful Retirement” is available online at Apple’s
iBookstore, Amazon.com, Sony’s Reader Store, Barnes &
Noble, Kobo, Borders Books, Diesel eBook Store, and Google
Editions. It mirrors a recent article by CNN on the
benefits of the country, including increased rental
possibilities.