REVERSE MORTGAGES – Strategies for using a Reverse Mortgage

SUPPLEMENTAL INCOME STRATEGY

THEORY

Obtaining a conversion mortgage will allow a borrower to draw consistent supplemental income from their home equity through a monthly (tenure or term) payment stream. This has the benefit of taking pressure off the borrower’s retirement portfolio and extending the borrowers assets over a longer term.

Business Cycle

Business Cycle

As a passive strategy, this is not dependent on the market. A bear market or bull market will not impact the way a borrower thinks about, or potentially uses, their home equity with this strategy.

Portfolio

Portfolio

This strategy allows the borrower to draw less from their portfolio to meet their needs. As you can see, the use of home equity during this time allows more money to remain in the portfolio.

Source of Cash Needs (Draws)

Source of Cash Needs

A portion of the income that is needed will come from home equity that is converted to monthly payments. Any additional funds would be drawn from the portfolio until the portfolio is depleted.

Net Equity Position

Net Equity Position

When a retirement portfolio runs out, a borrower may choose ① to sell the home and use the funds from the sale, or ② stay in the home and use the liquid home equity that was made available.

SUMMARY

In lieu of exclusively drawing down a retirement portfolio, a borrower using the Supplemental Income Strategy would convert a portion of their home equity into a steady stream of cash via monthly (tenure or term) payments. Substituting that payment stream for income a borrower would normally draw out of the portfolio allows more money to remain in the portfolio, making it last longer.

ASSUMPTIONS

  • Market returns for years 2000-2012 are weighted Barclays Aggregate (40%) to S&P 500 (60%).
  • Draws from retirement portfolios are independent of, and not affected by, any other income or defined benefit plans the homeowner may have.
  • Draws from retirement portfolios are not impacted by extinguishing a forward mortgage with a conversion mortgage or by stopping payments made toward a conversion mortgage.
  • Payments toward conversion mortgage principal balances continue until the loan balance reaches a minimum amount ($50) necessary to maintain, or keep open, the conversion mortgage.
  • Initial Mortgage Insurance Premiums (IMIP) was set at 2 percent.
  • Annual Mortgage Insurance Premium (AMIP) was set at 1.25 percent.
  • Lender’s margin was set at 2 percent.
  • Conversion mortgages are assumed to be FHA insured Home Equity Conversion Mortgages.
  • The average 10-Year Swap rate for year 2000 was used to establish the expected rate for the 4 hypothetical homeowner scenarios.
  • All 4 hypothetical homeowner scenarios assumed the borrower to be age 62 in the 2000 calendar year and refinanced into a conversion mortgage during that year.
  • No co-borrowers are assumed to exist in the 4 hypothetical homeowner scenarios.
  • All 4 hypothetical homeowner scenarios are assumed to have 30-year fixed-rate forward mortgages at 5% with an unpaid principal balance in the 2000 calendar year (Roger $10,000 UPB, Joan $10,000 UPB, Sally $20,000 UPB, Tom $50,000 UPB).
  • All 4 hypothetical homeowner scenarios are assumed to have an original mortgage amount (Roger $50,000, Joan $120,000, Sally $250,000, Tom $300,000).
  • All 4 hypothetical homeowner scenarios are assumed to have a monthly cash need as a percent of retirement portfolio.
  • Homeowners monthly cash needs are adjusted for inflation.
  • Each hypothetical homeowner scenario ends if there is no more money left in either the conversion mortgage’s line-of-credit or the portfolio.
  • In the years between 2000 and 2012, all 4 hypothetical homeowner could have followed any one of 4 home equity use strategies during retirement. The results for each are calculated. The strategies are as follows: Income Optionality Strategy, Supplemental Income Strategy, Portfolio Management Strategy, and Asset Management Strategy.

DEFINITIONS

  • Active Strategies – Those strategies that may be influenced by market conditions.
  • Baseline – Shown as a black dotted line, this demonstrates the general pattern of retirement portfolio draws and net equity position without the strategic use of home equity.
  • Business Cycle – For active strategies, bull and bear markets may influence how much is drawn from a retirement portfolio.
  • Line-of-Credit (LOC) Draw – Home equity that is made available through a conversion mortgage may be accessed through line-of-credit draws and used for any purpose.
  • Net Equity Position – This shows the expected gain at a given time if the borrower were to choose to sell the home.
  • Passive Strategies – Those strategies that are not influenced by market conditions.
  • Portfolio – The sum of funds that are available for financing an individual’s retirement, excluding the equity in the home.
  • Portfolio Draw – Periodic draws from a retirement portfolio.
  • Source of cash needs (Draws) – For these strategies, there are optimal times to fund cash needs with portfolio draws, and other times where it makes sense to draw from the conversion mortgage line-of-credit (LOC).

DATA

DISCLOSURES

  • While real economic cycles and conditions are used in these examples, past performance is not indicative of future results.
  • All persons appearing in this work, including Roger, Joan, Sally, and Tom are hypothetical borrowers and are for educational purposes. Any resemblance to real persons, living or dead is purely coincidental.
  • Historic conversion mortgage estimates are based substantially on the FHA Home Equity Conversion Mortgage program available in year 2000, and will therefore not match current projections.
  • Given the same inputs today (age, interest rate, and home value) results for drawable equity and starting line-of-credit amounts may differ.
  • Conversion mortgages do not require regular monthly principal and interest mortgage payments. However, as with traditional mortgages, the loan balance will grow when payments made by the borrower are less than the accrued charges. This is known as negative amortization.

NMLS 483490 / CalBRE 00935469                                                    equal_housing_lender

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About valoliver

I was born in San Francisco, raised in San Mateo. I have three children. I have been in the Mortgage industry for over 30 years.
This entry was posted in Equity, Home Financing, Mortgage Rates, Mortgages, Rates, Real Estate, Real Estate Mortgages, Retiree, Retirement, Reverse Mortgage, Reverse Mortgagee, Reverse Mortgages, Spirituality and tagged , , , , , , . Bookmark the permalink.

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