Funding Retirement with Home Equity

by Kent Kopen| Apr 24, 2017 | 0 Comments

HELOC vs RMLOC - Picture 1.jpgIt’s easy to find people who say you should not touch the equity in your home, but that tends to be an emotional response that is out of sync with Americans' reality.  This is why many leading academic journals and news organizations are talking about the importance of home equity in retirement.


In a previous era, people paid off their homes, they had lifetime employment, pensions paid their bills and they didn’t live as long.  Now, healthcare inflation far exceeds wage growth, employment isn’t nearly as secure, and few have pensions – at least ones they can rely upon.


There’s an old joke, “Why do crooks rob banks?”  Answer, “Because that’s where the money is.”


Imagine you need $100.  You have $20 in a coffee can and $80 in piggy bank.  Guess what… you’re getting in to that piggy bank.  The only question is: can you do so without destroying it?  Do you have a key?


This is a two-part article because the topic is too big and too important to summarize and leave out key details.  Part one is about home equity and why it is key to meeting retirement needs.  And how to safely reposition debt to make the most of what one has.  In a perfect world, we’d all have big bank accounts, cushy pensions, and we could leave the home alone.  But that’s not reality.


Part two covers the two main ways to access home equity (house-based wealth) without selling the home.  For homeowners 62 and up, one method is much safer than the other but it’s the method most people don’t know much about.


Home Equity


To calculate home equity, subtract what is owed from the value of the house.


How to calculate home equity


The reason home equity is going to be such an important topic for the next several decades is because the U.S. has a retirement savings deficit of $6.8 trillion.  There are several structural reasons for that saving shortfall: the disappearance of pensions, the last big recession, full-time employment challenges for those over 50, cost of health insurance and health care, etc.


Another factor is that many near-retirees have not seen the value of their retirement plans fully rebound from the crash because they have not been fully invested since the low of March 2009.  Sadly, normal people tend to ‘sell low’ and ‘buy high.’  This happens because we’re all emotional creatures; we’re hard-wired to survive.  In economics, loss aversion refers to people’s tendency to prefer avoiding losses to acquiring equivalent gains.


Loss aversion explains, why over a 30-year period, the average equity fund investor’s return was 3.79% but the S&P 500 average return was over 11%.{c}  One of the key values of a good financial advisor is that they help save us from ourselves.  Our savings deficit is what moves home equity into the spotlight.


Even though Americans haven’t saved enough, many have considerable home equity.  According to the U.S. Census Bureau, Americans 65 and older have over 86% of their net worth tied up in the equity in their home.


The Urban Institute in Washington, DC, reports Americans have over $11 trillion dollars in untapped home equity.  The amount held by homeowners who are 62 and older is $6.2 trillion.


Since most people over 60 have the bulk of their wealth tied up in home equity, it is going to have to be the source to fund expenses.


Optimizing Equity by Repositioning Debt


Optimizing equity is about doing the most with what you have.  With home equity, it’s about retaining ownership and control of an appreciating asset while meeting other financial needs.  Last month I wrote an article on what a strategic mistake it can be to sell a house and rent.


A home equity conversion mortgage (HECM) is a tool to reposition debt so financial needs can be met without selling the house.  The US government guarantees these loans because they know seniors need a safe way to access wealth without getting hurt.


Most people are familiar with the concept of repositioning debt when it comes to substituting tax deductible debt for non-deductible debt.  For example, using a home equity loan to pay off high-interest credit cards.


Debt can also be repositioned in terms of debt that requires monthly payments versus debt that has no monthly payment.  That’s exactly what a HECM does.  It delays repayment until the loan is paid off, years or decades later.


The following are good reasons to consider this strategy:

  • Eliminate current mortgage payments
  • House maintenance or improvements
  • Medical or dental expenses
  • Prescriptions
  • In-home care
  • Medicare gap insurance
  • Long-term care insurance
  • Maximize Social Security 

Usually, the biggest budget buster for retirees is making payments on existing mortgages, cars, and credit cards.  A recent study by Northwestern Mutual reported that of those Americans with debt, 45% spend up to half of their monthly income on debt repayment.  By repositioning debt, and optimizing equity with a HECM, we’ve helped people improve their monthly cash flow by double or more.


Evaluating the Strategy


There are three questions that must be answered when considering this strategy and/or any home loan:

  1. What will it cost?
  2. How will it affect my monthly cashflow?
  3. What is the long-term wealth impact?


One of my favorite authors is Jack Guttentag, a 93-yr old, professor emeritus at Wharton University.  Professor Guttentag, also known as The Mortgage Professor, teaches that there is wide variance in the fees people pay for home equity conversion mortgages.  He repeatedly underscores the importance of becoming educated and shopping different lenders.


For example, there are companies that charge an origination fee of $6,000 (the maximum allowed by FHA) and others who charge zero.  There are companies that offer a lender credit to cover closing costs and others that don’t.  Some companies offer to pay all closing costs but the loan they use is not ideal in a rising rate environment.


Money Now - Cashflow

Most people cannot visualize mathematics, which is why we built a tool called The Financial Snapshot.  With it we generate an easy-to-read, one-page report that helps people see the Before versus After debt repositioning difference.


Check out a typical case below where a home equity conversion mortgage was used to pay off an existing mortgage, a car, and high interest credit cards.  Notice the difference in how much money remained after making monthly installment and revolving debt payments.


Before debt repositioning, the family had only $553 per month to live on.  Afterward, they had $2,938 per month.  It’s about substituting debt that requires payments with debt that doesn’t.


     Homeowners financial chart - before reverse mortgage     Homeowners financial chart after reverse mortgage



The cashflow impact was an improvement of $2,938 - $553 = $2,385.  That’s a 430% increase in money available each month for food, utilities, transportation, medical bills, etc.


More than that, having four times as much disposable income is the difference between saying ‘No’ to just about everything and being able to say ‘Yes” more often.  It’s the little things that make life rich - being able to afford a birthday card, not scrimping on a special meal, etc.


This is a complete change in lifestyle.  People can make payments on a HECM if they don’t need that much – they have choice and control.


Unquestionably, one of the biggest concerns people have when considering a HECM (accessing home equity) is the impact the loan will have on their heirs.  The big question is, “Will there be any money left for the kids?”  That is the third question: what is the long-term wealth impact of the strategy?



Money Later - Wealth Impact

Most people are surprised to learn how much equity remains when they get a home equity conversion mortgage.  The reason why is because houses generally appreciate over time, whether they're mortgaged or not.  Here are charts showing how much equity the day the loan closed and how much is expected 20 years later.{a}


     Homeowners equity at start of reverse mortgage          Homeowners equity 20 years after reverse mortgage



Often the reports show more equity in the future than there is today.  All lenders use the same software with the same HUD/FHA assumptions. 


Invariably, someone will say, “There’d be even more equity for the kids if the parents didn’t take out a loan.”  That’s true but kids usually prefer their parents getting the loan to having them come live with them and they have to help pay the parent’s bills.


This is a difficult, unpleasant topic, for sure but it’s happening across America right now.  With ten thousand Baby Boomers turning 65 each day, it’s only going to become more common.


The bottom line is, if you or homeowner you love is trying to figure out how to better afford retirement, a home equity conversion mortgage is an important tool.  It is critical that a professional analyze the three key impact questions: cost, cashflow, net worth so you can be clear about the benefits of taking action.


To have a custom report built with your specific numbers, click the Financial Snapshot button below.



Financial Snapshot




In part two, we'll take a deeper dive into the differences between a HECM (Home Equity Conversion Mortgage) and a conventional HELOC – the type offered by banks and credit unions.  One is dangerous for retirees.


{a} Equity calculation based on Reverse Mortgage Analysis Amortization Schedule ‐ Annual Projections.

{a}  Values are estimates only, based on an expected house appreciation rate of 4%.

{a}  Refer to FHA HECM Proposal report for details. Rates subject to change without notice.