Reverse

Feature: The Greatest Asset

Written by Jessica Guerin, as originally published in The Reverse Review.

In 2007, just before the housing bubble burst, the Center for Retirement Research at Boston College conducted a study on retirement preparedness and home equity use. When asked if they planned to utilize their home equity to finance living expenses in retirement, 72 percent of the 2,600-plus respondents said no.

But, as the center’s study went on to explore, for most Americans, their home is their greatest asset, one that many will not be able to ignore. The study revealed that people were holding on to a belief common among older generations: that the house was a sacred entity not to be touched, a protection against the worst-case scenario or a gift to bequeath to their children. Even then, pre-recession, the center concluded that this perspective is likely to wane as economic realities hit home. The fact is that Americans are living longer, approaching a long retirement without pension plans, with nominal Social Security benefits, and little in the way of savings. Many will need to consider the use of their greatest asset.

“While most retired households do not currently tap equity, this approach may be a luxury that future retirees will not be able to afford,” the center’s brief states. “As the baby boomers retire and the retirement income system contracts, housing equity is likely to become an increasingly important source of support.”

Toss in a devastating economic recession and fast-forward six years, and the financial deficit confronting many of America’s retirees is more pronounced than ever.

Reality Hits Home

Highlighting the realities of a post-recession world, a 2013 survey from Ameriprise Financial paints a different picture. Nearly half of the survey’s 1,000 respondents said they expect to use home equity to fund retirement. The tides have started to turn.

Chris Mayer, a professor at Columbia Business School and the CEO of Longbridge Financial, says this trend is inevitable because of the severe economic realities facing today’s retirees. “There is a really, really large gap between retirement assets and retirement liabilities,” he says, pointing to data that suggests an $11 trillion gap between the available assets and overall needs. Down the road, he says, home equity might be able to offer as much as $6 trillion to fill in the gap. Right now, homeowners aged 65-plus have just under $4 trillion in aggregate home equity, according the NRMLA/Riskspan home equity index.

“It still doesn’t solve the entire problem,” Mayer says. “There are lots of parts to this, but I think any solution that deals with the retirement crisis is going to have to involve home equity.”

Amy Ford, director of home equity initiatives at the National Council on Aging, says homeownership rates and a notable sense of economic insecurity among older Americans will contribute to the need for many to access their equity.

Ford points to recent Census data that states 80 percent of Americans 65 and older are homeowners. Juxtapose this, she says, with NCOA’s own survey results, which reveal that 60 percent of older adults are economically insecure. “Considering these two factors, I do think people will be looking at equity in creative ways.”

Shelley Giordano of the Funding Longevity Task Force agrees. “There are several economic realities out there that today’s retirees are having to confront,” she says, adding that use of their home’s equity is one of them.

“As people age and they are tapping into their other assets, the ratio of their housing wealth [to their other assets] generally increases,” she says. “The body of research out there is taking a look at how that asset can be used or incorporated in the overall wealth picture.”

Accessing Your Equity

There are several ways homeowners can tap into their equity and all of them vary in their terms for disbursement and repayment; requirements for age, income and credit status; and tax benefits.

A traditional home equity loan, often referred to as a second mortgage, may be the most utilized method to convert one’s equity into cash. This fixed-rate loan allows homeowners, regardless of their age, to borrow a lump sum up to $100,000 provided they have at least 20 percent equity in their home, which they must repay over a set period of time in monthly installments.

A home equity line of credit, or HELOC, is another common tool that allows homeowners to access their equity. With a HELOC, borrowers can draw funds from a line of credit as needed, making minimum interest payments and eventually paying back the loan in full.

While these types of loans may be useful for homeowners who have a steady income that would enable them to repay the loan balance, they do not provide a great solution for older Americans whose resources will decline as they enter retirement. For those seeking a long-term solution to a problem that will escalate as they exit the workforce, a HECM can provide a smart solution.

A standard HECM can offer qualified homeowners over age 62 access to a portion of their equity without the burden of repayment. The homeowner retains title to the home and is obligated to make tax and insurance payments and keep the home in good repair.

Perhaps most importantly, the loan doesn’t need to be repaid until the borrower moves, sells or passes away. “That’s the critical difference, of course,” says Ford. “It can provide a level of security if one wants to remain in their home, if they keep up all the obligations of the HECM, which is an important part.”

Mayer says he has long considered HECMs to be a critical tool that could help many older Americans fill their income gap. He wrote his first piece about reverse mortgages in 1994, when he was an economist at the Federal Reserve. “It was clear to me and clear to many economists even at the time that home equity was something that was a vastly underutilized asset,” he says.

The HECM also has a line of credit option, which some financial experts have praised as a smart tool that can help borrowers leverage their equity to hedge against dips in the market.

Giordano says establishing a HECM line of credit gives borrowers tremendous flexibility. “Instead of pulling from your portfolio and locking in your losses in a bad market, you can use a reverse mortgage instead, and when your other assets rebound, you can take down your line of credit, if you want to.”

Giordano says older homeowners would be wise to consider the strategic use of a HECM line of credit. “When people move into retirement, they should be looking at their housing wealth as an important component. Not that they have to use it, but if they at least set up a standby line of credit, they’ve diversified that asset.”

“What everyone in America is trying to achieve is retirement income security, and how does housing wealth fit into that? We have all these researchers saying, wait a minute, we have this giant undiversified asset sitting out there, what could its role be? When they look at the HECM line of credit and compare it to the HELOC, they find that a HELOC can be canceled, just when people need the money most, when the market is going haywire,” she says. “Compare that with a HECM and you have a guaranteed credit availability as a contractual obligation. So that means regardless of what the property values are doing in your neighborhood 20 years from now, you’re still getting that growth in the line of credit—it’s automatic and insured by FHA.”

Giordano says finding a lender who will offer credit for closing in exchange for over-par pricing or premium pricing helps reduce the cost associated with taking the loan. (She notes, however, that not all lenders will do this.) With lender credits, she explains, the client will accept a higher interest rate and get less initial credit availability, but would be able to establish a line of credit at an extremely low rate.

“You want to coordinate its use in a conservative and prudent manner with your other assets—not that one is better than the other necessarily, it’s just circumstances in any particular year during your retirement could dictate to you which asset you should be using.”

Overcoming Obstacles

Despite research suggesting that HECMs could be strategically employed to ensure financial security in retirement, the general public remains reluctant. For some, there are emotional barriers at play that give them a sense of unease about extracting their equity.

“There’s an emotional attachment for some people to the home they raised their kids in,” Mayer says. “But for many people, I think it’s even more basic, which is where they’re going to live,” he says. “I think this emotion about using home equity is really driven by this concern that if you use your home equity, there’s some risk you’re going to lose your home, and if you lose your home, where are you going to live?”

Of course, the desire to leave one’s home to their children is another barrier that prevents some from utilizing their equity. “Many people don’t have a lot of savings, so their home is the biggest thing they could imagine giving to their kids,” Mayer says. “Interestingly, when you survey the kids, they say they don’t want the home, and even more so they want their parents to use their assets to take care of themselves.”

When it comes to the HECM, others may be hesitant because of concerns about the safety of the product and misconceptions about how it works. Even financial advisors are hesitant to recommend a HECM to clients. Mayer says he thinks planners recognize the value of the product, but have practical problems with suggesting its use.

“When I talk to financial planners—and I talk to a lot of them these days—I don’t hear them say, ‘This is a bad product’ or ‘This is a bad idea.’ What I hear them say is more specific. The first is ‘Am I going to get in trouble for doing this? If I recommend a reverse mortgage are there regulatory concerns or other problems that are going to [create problems]?’ The second thing I hear is, ‘Well, it makes sense from my perspective, but when I send it to my clients, they are going to have a bad reaction,’” Mayer says. “I hear them nervous about how to implement it. They don’t understand the product well.”

While many are hopeful that recent policy changes and an industry-wide education campaign will help turn things around, changing people’s perceptions will take time.

Mayer says the involvement of larger institutions would do a lot to bolster the product. “Just because people say that homeowners should do it does not mean they will. It requires institutional reforms, it requires industry reforms, and it really requires more brand-name institutions using HECMs and being associated with HECMs and home equity over time to create the credibility that the product and the industry need.”

For proponents of the HECM, it’s just a matter of time before people start to consider their home in their overall retirement plan.

“This is the first generation that is trying to figure out this retirement funding to get them through what could be a really long retirement period,” Giordano says, adding that home equity is bound to play a key role.

“It’s just another asset to be judged against the other assets… For most people, it’s an increasingly important component of their overall wealth, and the body of research out there is demonstrating that the prudent use of housing wealth can protect other assets.”

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