Wade Pfau, professor of retirement income at the American College of Financial Services and founder of RetirementResearcher.com, has long been seen as an authority on how reverse mortgages can be well-implemented into a senior’s retirement plans to reach financial goals. Because of his general dedication to understanding the space, Pfau has observed a series of changes that the reverse mortgage program has undergone over the years both from within, and from external entities like regulators.
Pfau shared some of these observations and additional “intuition” he has gained over the past few years which have informed revisions to the latest edition of his reverse mortgage book, “Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement.” The new intuition comes in the form of additional methods that can be employed for incorporating a reverse mortgage into a retirement plan, and how a reverse mortgage can be used as a “buffer asset” during a bear market.
New intuition on reverse mortgage strategies
The new intuition that the new edition of the book benefits from comes down to the length that financial resources last in retirement, Pfau says. Part of this comes from the incorporation of a Home Equity Conversion Mortgage (HECM) into an existing portfolio, while the other part comes down to strategic use of a reverse mortgage’s proceeds in certain situations.
“If you can just lower the distribution rate from the investment portfolio slightly, I show how that can work to have so much greater sustainability for the portfolio,” Pfau explains. “Or how, instead of ending up with $0 at the end, you might still have a million dollars out of an initial million dollars by just making a small change to the portfolio distribution. And the other angle there too, is this idea of the buffer asset, where maybe you’re spending at a regular rate from the investment portfolio. But if in certain circumstances, you could skip a distribution from the portfolio at a key moment in the retirement, [such as] after a big market downturn, that can provide so much positive impact to sustaining and prolonging the investment portfolio.”
Where a reverse mortgage could then come into view during this time is if it can be used as an asset to draw from to cover the spending that would have otherwise come from the investment portfolio either on an ongoing basis, or for a specific time period, he says.
“Where the reverse mortgage steps into that is [if a retiree asks] ‘what if I could use the reverse mortgage to cover spending either just on an ongoing basis that can help to reduce the spending rate from the investments, or with that buffer asset idea at key moments in retirement? Can I preserve my investment portfolio by taking the distribution instead from the reverse mortgage?’”
Portfolio sustainability vs. a ‘last resort’ approach
Demonstrating that these synergies can have a demonstrable impact to portfolio sustainability is a key component of the new intuition, Pfau explains. These synergies don’t erase the upfront costs that are associated with such a loan, but weighing those costs against the future potential benefits that a reverse mortgage could provide is an important part of determining whether or not this is the right option for an individual senior, he says.
“Yes, there are costs associated with the reverse mortgage in terms of upfront costs and interest on the loan balance,” he explains. “But if the gains in preserving the portfolio are greater than the cost of the reverse mortgage, you can create a net positive impact. You pay off the loan balance and still have money left over, and have a better retirement outcome by strategically using the reverse mortgage throughout retirement versus using it as the last resort.”
The “last resort” phrase is one likely very familiar to most reverse mortgage professionals, and is often described as the only scenario that a reverse mortgage is a viable option by outside observers. The last resort option in direct comparison with a more nuanced, comprehensive retirement strategy which uses a reverse mortgage should be weighed based on the benefit to the end-user, Pfau explains.
“I’m trying to give more intuition about why that last resort doesn’t work as well as a more coordinated type of strategy,” he explains. “The intuition is just because of these benefits that [loan] can create in helping to preserve the investments. It’s not a reverse mortgage in isolation, but it’s the reverse mortgage within the context of [the idea that if a senior] spends from the reverse mortgage, they don’t have to spend from the investments. That can help to create a better overall outcome for the financial plan.”
Expanding reverse mortgage understanding through proprietary products
Another new addition to the book’s third edition is a section on proprietary reverse mortgage products, which lenders offer without a direct association with the Federal Housing Administration (FHA)-backed HECM program. Since the last edition of the book, several major reverse mortgage lenders have expanded their proprietary product suites, which warranted a mention in the book, Pfau says.
“That section is not extremely long, but I tried to get a sense of the different products out there,” Pfau says. “There’s definitely been a lot of developments since the second edition in terms of wider acceptance or use of different proprietary options, which on a state by state basis [could] potentially give access [to reverse mortgages] to people at age 55 or 60 instead of having to wait to 62. We’re starting to see the development of a line of credit as part of a proprietary option, which doesn’t work in the same way as the HECM line of credit. But at least it’s a starting point.”
Originators may have a harder time generating proprietary business since those products do not have federal insurance guarantees backing them, so the terms are not as “generous” as the HECM program, Pfau says. Still, lenders focusing on the proprietary space as a ground for industry innovation is certainly noticed.
“I think we’re seeing a lot of innovation where there are increasingly proprietary options available to help people in a number of different circumstances, whether it’s because they’re too young for the HECM or because they may have an outstanding mortgage balance that exceeds what they could get through the HECM, and so forth,” Pfau says. “So, I think it’s an important option. And it was time to include more coverage of that in the book in a way that was not there in the past editions.”
Listen to the full discussion on The RMD Podcast, or read part one of the interview.