Recently I had a fellow advisor ask my thoughts on his clients using a HECM to create better retirement efficiencies. The clients were ages 65 and 70 with around $900,000 in savings. Based on their current lifestyle, the advisor completed a series of calculations that revealed their probability of retirement income success could be increased by more than 20% if they simply eliminated their large monthly mortgage payment.
They had a modest home worth $340,000, but owed $223,500. A reverse mortgage calculator revealed there would be a shortfall of around $60,000 that they would personally need to make up (Though many lenders will give a credit to offset some of this). So, they determined it would be worthwhile to pull funds out of savings (preferably non-qualified funds like a non-performing CD) to cover the shortfall and eliminate their existing mandatory monthly mortgage payment.
Flexible Payment Times and Amounts
I agreed with the metrics and wisdom, but suggested if they could afford to make a much smaller monthly payment for a few years, they could do something even better. Keeping their mortgage payment while changing their mortgage partner could be the latest retirement income game changer. (For related reading, see: Picking the Right Reverse Mortgage Lender.)
Here is how it works:
The client chooses to do a HECM exchange with a qualified HECM retirement income specialist, but because the HECM does not make enough money available to pay off the traditionally amortizing loan, the client will need to use $50,000 – $60,000 from their savings to make up the shortfall.
The client then begins to make a $1,500 monthly payment for the next 15 years on the HECM. They can choose to pay for a shorter period of time, it’s just that the longer they pay the bigger the benefit (see below).
The payment amount and time it’s paid is 100% voluntary and flexible. One month they pay more, the next month they pay less or don’t pay at all. They can use RMDs, tax returns or any number of ways to make a payment. But make no mistake, making payments on an HECM creates a powerful longevity bridge.
The Magic of Making Payments on HECMs
It is understood that everyone will not be able or willing to make a monthly payment. But for those who can, look what happens:
- For every dollar they pay towards the HECM, the outstanding loan balance decreases (red line).
- For every dollar they pay, the reverse mortgage line of credit (ReLOC) grows (green line). The ReLOC is compounding currently at close to 6%.
- At some point it is even possible that the ReLOC could surpass the home's value (blue line), thus providing a type of equity insurance
- This appreciation of the ReLOC is tax free and is not counted as income. The funds withdrawn are tax free as well.
Here’s the Math
Notice below how fast the voluntary payment replenished what was used from savings—by the end of year three. This strategy uses the powerful and underutilized power of the 6% tax-free growth factor of the ReLOC. Remember how much the CD/money market was earning?
The ReLOC now can grow exponentially:
- $266,721 in year 10
- $644,177 in year 20
- $1,204,523 in year 30
Retirement may last a long time, and most boomers don’t have enough money saved. The vast majority have not planned for the two biggest unexpected expenses: out-of-pocket medical costs and long-term care costs. Those two can easily reach $250,000 to $1 million in unplanned costs.
Creating a standby ReLOC by continuing to make a monthly payment could make sense. At least enough sense that it should be part of the conversation. (For related reading, see: The Reverse Mortgage: A Retirement Tool.)