The use of reverse mortgages as a retirement planning tool should receive much more consideration earlier on in planning processes rather than as a loan of last resort, writes a financial planner after comparing the loan to traditional amortizing mortgages kept in retirement.
With low interest rates suppressing both retirement portfolio yields and borrowing costs, some borrowers may be tempted to keep their amortizing mortgages in retirement, Michael Kitces writes on his financial planning new blog.
The decision to keep a forward mortgage in retirement is not without risk, however, Kitces cautions, outlining potential dangers including equities that don’t perform as expected and failure to generate a return in excess of the borrowing cost during a relevant time period.
Even when returns do add up, he continues, ongoing monthly payments on traditional mortgages create a “sequence of returns” risk for retirees, as withdrawals to fulfill mortgage repayment obligations could deplete retirement portfolios during an extended period of bad returns to the extent there isn’t enough money left over for when good returns arrive.
“From this perspective,” he writes, “retirees should perhaps consider the reverse mortgage instead.”
Reverse mortgage loans have remained relatively unpopular, he says, due in part to high upfront fees, and are often viewed as a loan of last resort.
“The reality is that the lack of any cash flow obligations for a reverse mortgage actually allows it to eliminate the sequence risk from the mortgage-in-retirement strategy,” says Kitces.
However, there are still some caveats to going the reverse mortgage route, writes the financial planner, including the ongoing borrowing costs, lending limits that may reduce the loan’s usefulness for more affluent clients, and upcoming changes soon to be implemented by the Department of Housing and Urban Development that will substantially change the program.
Caveats aside, reverse mortgages can alleviate sequence risks associated with traditional amortizing mortgages, he says, which can make them especially appealing to retirees with certain risk preferences.
“Thus, while reverse mortgages have typically been viewed primarily as a ‘loan of last resort’ for those who have entirely depleted their other assets,” he concludes, “the reality is that reverse mortgage strategies should perhaps receive much greater consideration in the earlier stages of an affluent retirement plan.”
Read the full column here.
Written by Alyssa Gerace
