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what are the consequennces to a hecm if the housing market crashes

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Many retirees or those anticipating retirement often own their ain homes. It is typically paid off and thus tin be used every bit a source of funds either through a home disinterestedness loan, home equity line of credit (HE-LOC), the outright sale of the property, or a reverse mortgage (RM). For instance with the HE-LOC, the homeowner can withdraw funds every bit needed, but whatever funds withdrawn must be repaid with interest sometime in the future. The dwelling disinterestedness loan, although like, is usually used for a lump sum payout with periodic repayments (usually monthly) over a stock-still period. With the sale of the home, the homeowners receive a lump sum of cash, simply they are faced with a major decision on where to live—apartment, downsized habitation, or moving to a locale that offers cheaper housing options. Although the opposite mortgage offers diverse options for withdrawing funds, the focus of this paper is the line of credit (RM-LOC). Like the HE-LOC, the RM-LOC permits the homeowners to withdraw funds as needed. Where it differs from the HE-LOC, the RM-LOC funds do not take to exist repaid until the owners vacate the belongings or pass away. Additionally under the RM-LOC, the homeowner tin remain in the home regardless of when the funds are repaid. Our analysis shows an additional advantage of using this RM-LOC is that it tin can exist used to beginning downturns in the equity market that would negatively affect a portfolio consisting of disinterestedness and debt investments that are being used for discretionary retirement funding.

Literature Review

The primary purpose for the creation of the contrary mortgage was to give lower-income homeowners with a minimum historic period of 62, an opportunity to convert the equity in their homes into monthly checks and/or lines of credit while remaining in their home. Several academic and practitioner studies focus on reverse mortgages. For example, Chatterjee (2016) finds support for several generalities: few homeowners participate in opposite mortgages; participants are probable to be over 67 years of historic period; and homeowners with long-term care insurance are less probable to take to depend on reverse mortgages to assistance with cash menses needs. Surprisingly, participants are take chances-adverse and from the 2 highest quartiles of net worth. Chatterjee also notes that financial advisors are beginning to suggest adding funds from a opposite mortgage to a diversified portfolio to leverage their majuscule investment accounts to sustain current consumption levels. Other needs include having adequate funding for unanticipated medical and long-term care costs.

Although the contrary mortgage was designed for lower-income individuals as a means of helping them remain in their homes, some qualified borrowers in the upper-income quartiles are now using reverse mortgages as an investment strategy to avoid liquidating stock portfolios during downturns in equity markets. This type of investment strategy is advocated past Salter, Pfeiffer, and Evensky (2012). Using Monte Carlo simulations with diverse withdrawal rates of 4, five, and 6 percent; a home value of $250,000; and a diversified portfolio value of $500,000 within an inclusive investment strategy, they detect back up for using a reverse mortgage. Their take a chance management strategy improves portfolio survival rates by a significant amount past mitigating the effects of market volatility (i.due east., the risk of having to sell investments within depreciated equity markets). They focus on utilizing the RM-LOC funds during bear markets with repayment during balderdash markets. A stumbling block to incorporating this analysis in real-fourth dimension is knowing when the bear and balderdash markets start and stop. Also, their findings relied on the home equity conversion mortgage (HECM) Saver pick which is no longer available.1

Pfau (2017) reinforces the potential benefits of this RM-LOC investment strategy to minimize the effects of equity market downturns on one'due south portfolio.2 Similarly, Sacks and Sacks (2012) test three contrary mortgage investment strategies. Their third strategy, using the RM-LOC to supplement drawdowns of a portfolio during down markets, is similar to this assay, but without the periodic repayment of the RM-LOC. The general conclusion from their analysis is that an active investment strategy utilizing the RM-LOC produces essentially greater cash flow survival probabilities (i.e., there is less chance of running out of funds during the 30-year retirement assay). These benefits of the RM-LOC strategy are specially prominent during a volatile stock market and/or a low-interest debt market. Without calculation an RM-LOC to their investment portfolio, their analysis using diverse earnings models testify a high probability of outliving one's funds. An increasing life expectancy adds to the importance of using the reverse mortgage for reserve funding.

Rasmussen, Megbolugbe, and Morgan (1997) suggest that the low usage of reverse mortgages is counterintuitive. Figure 1 shows the number of reverse mortgage originations by twelvemonth. Rasmussen et. al., further annotation that approximately lxxx% of older homeowners could do good from taking out a reverse mortgage loan. Nakajima and Telyukova (2017) reinforce the advantages of using reverse mortgages for their original purpose, i.e., permitting older homeowners to utilise the equity in their home to pay expenses and continue to live in their dwelling. They likewise reinforce the pocket-sized number of market participants by documenting that only 1.nine% of eligible homeowners had contrary mortgages in 2013. Key factors cited for this low usage include inheritance considerations and the high endmost costs associated with reverse mortgages. Only their research indicates an average welfare gain of $1,770 per borrower for participants of reverse mortgages. Researchers, Apgar and Zhu (2005), reinforce the fact that home equity represents the largest single nugget class endemic by most individuals age 65 or older. Thus, a reverse mortgage offers an opportunity for many financially struggling senior homeowners to remain in their electric current home. In that location is also the choice of using the disinterestedness value built up in their current domicile to downsize and guarantee the opportunity to live out their lives in their new home. This assumes they tin fulfill the opposite mortgage requirements of proper budget of the domicile and timely payment of insurance and taxes.

News reports are too becoming more favorable towards contrary mortgages. For example, virtually 93% of reverse mortgage media coverage was either positive or neutral in the second half of 2016, according to information compiled from the PR NewsWire monitoring service and the National Reverse Mortgage Lenders Association. Of the more than than 5,000 news stories most contrary mortgages in 2016, only 4.2% conveyed negative comments. Leading magazines have also run favorable articles on reverse mortgages such as Forbes and Money.3 A nationally syndicated PBS personal finance program, WealthTrack, also dedicated an episode to the new bookish thinking around reverse mortgages and retirement.iv Jason Oliva highlights ten must-read contrary mortgage financial articles which are practitioner-focused.5

The contrary mortgage, officially called the abode equity conversion mortgage (HECM), was initially authorized by the Housing and Community Development Act of 1987.vi Reverse mortgage (RM) and HECM are used interchangeably inside this manuscript. One of the unique requirements within this Human action for obtaining a reverse mortgage is to obtain financial counseling. An overview of HECM counseling protocol is available from the National Reverse Mortgage Lenders Association (NRMLA).7 Information provided include a pre-counseling data packet (Preparing for Your Counseling Session); the National Council on Aging (NCOA) booklet "Use Your Home to Stay at Home – A Guide for Homeowners Who Need Help At present"; a checklist of word points focused on reverse mortgage alternatives; and a list of FAQ. The mandatory counseling component of the HECM opposite mortgage has also received some attention in the literature. For instance, are the requirements to become a certified HECM counselor adequate in terms of identifying all the alternative funding options or providing a sufficient assessment of potential fraud? Rose (2009) outlines an pick that is typically overlooked, i.e., the intrafamily auction and leaseback. Only since this is a circuitous financial maneuver involving detailed record-keeping over the life of the loan, information technology is a feasible alternative for merely a modest segment of the potential opposite mortgage clientele.eight Seay, et al., (2014) discusses the lack of fraud awareness of HECM counselors. But the type of fraud highlighted occurs only within refinancing HECMs and HECM for purchase transactions which are not relevant to the give-and-take of the reverse mortgage line of credit choice applied to an investment strategy.

Comparison of Traditional and Opposite Mortgage Lines of Credit

Since the retiree has already purchased a domicile before retirement, we assume familiarity with a traditional mortgage. So before outlining our investment strategy, we review the reverse mortgage line of credit past comparison it to a home equity loan and line of credit.9 With this knowledge, retirees tin can brand more informed decisions concerning the implications of borrowing against the disinterestedness within their home, selling their home, or spending down the home'due south equity value through a opposite mortgage. Although both the home disinterestedness loan and an equity line of credit involve borrowing a sum of funds using the abode as collateral, the perspectives of the participants are vastly different. The home disinterestedness loan involves a lump sum of funds, whereas the equity line of credits entails a stock-still amount of funds that tin be withdrawn as needed.

To calculate the available cash flows to each product, 3 factors are needed: (ane) the desired amount to be borrowed through the disinterestedness loan or line of credit, (ii) the involvement rate charged past the lender, and (3) the period for the loan. To decide the amount of funds eligible to exist borrowed or withdrawn, all types of mortgage products rely on the underlying value of the property equally collateral for the loan. Notwithstanding the equity loan and line of credit are based, non on the underlying value of the home directly, just on the disinterestedness value the homeowner has established in the property (i.east., the amount of equity relative to any underlying loans confronting the property). This disinterestedness position is highly correlated to the interest rate charged. The bigger the equity position, the lower the risk to the lender, and thus the lower the interest rate charged all other things equal.

With a reverse mortgage, the borrower owns the dwelling house (or pays off a small balance owed equally part of the reverse mortgage process) and thus has a 100% equity position. Similar to the disinterestedness loan and line of credit, the homeowners in the reverse mortgage borrow against that equity position, but a cap on the line of credit is based on the ages of the borrowers. Since the sum of these expected payouts received are charged confronting this disinterestedness value over the term of the contrary mortgage, the qualifying amount eligible for withdrawal is much less than the qualifying amount for a typical mortgage product.ten

The amount eligible for withdrawal under the reverse mortgage contract depends on the value of the home, the underlying mortgage interest charge per unit, and the historic period of the borrowers.11 These latter ii features determine the HECM Principal Limit Factors (PLFs), which in plough determines the Maximum Claim Amount (MCA) commanded for withdrawals.12 For instance using the PFL tables, a seventy-twelvemonth-one-time borrower in a 5% interest rate environs would be assigned a PLF of 46.5%. This percentile decreases as involvement rates increase. For the same 70-year-quondam borrower at 6%, the qualifying percentage drops to 41.5%. PLFs also decrease the earlier the reverse mortgage is taken. At age 65, the percent drops to 43.0% and 37.8% for the 5% and 6% interest rates respectively. These factor rates are used to protect the lender against the fluctuations both inside the housing market and the interest rate levels over fourth dimension. Tabular array 1 shows a range of qualifying percentages across a variety of ages and interest rates. In the complete table, interest rates range from a low of three% to a high of 18.875% in i-eighth increments (0.125%). Thus, the borrowing base is based on the age of the borrower, property value, and the involvement rate at the time of origination, less any costs folded into the loan. Many borrowers will finance their closing costs, reverse mortgage origination fee, and the initial mortgage insurance premium (MIP). This Remaining Chief Limit is the corporeality that the borrowers have admission to and from which any outstanding liens on the property must exist paid at endmost. Although non shown in the select PLFs shown in Table one, the actual range of PLFs start from a low of 6.8% at age 62 with an 18.875% mortgage charge per unit to a high of 75.0% at age 99 and a 3% mortgage charge per unit.xiii

Table 1. HECM principal limit factors (PLFs).

The MCA is calculated by multiplying the representative PLF times the minimum of the belongings's appraised value at the time of loan awarding, its auction price, or the national FHA loan-limit currently set at $765,600. When borrowing as a couple, the non-borrowing spouse tin continue living in the home after the principal borrower passes abroad if all of the post-obit conditions are met: (one) go along making timely revenue enhancement and insurance payments, (ii) go on maintaining the belongings under the terms and conditions of the HECM, (3) exist legally married to the borrowing spouse when the reverse mortgage originally airtight, (four) lived in the property equally a principal residence throughout the HECM, and (5) exist able to obtain title to the property inside 90 days of the death of the principal borrower.

The interest rates charged for the regular and reverse mortgage products should be similar if they were for the aforementioned term, once again bold all else equal. One factor influencing the upwardly pressure level on the opposite mortgage rates is the increased adventure to the lender of the homeowners outliving the equity built into the loan.14 Reverse mortgages besides tend to have larger origination fees, which the lender sometimes absorb into the offered charge per unit. The lower loan to value ratio (i.due east., lower loan amount versus the disinterestedness being used equally collateral) and the shorter term to maturity associated with the RM-LOC help negate the differential in rates.

The term for the loan is based on the time frame the borrower wishes to use to repay the home disinterestedness loan. Although the most common terms for the traditional mortgage is 15 and thirty years of monthly payments, the habitation equity loan typically is over a shorter term ranging from 5 to 10 years. The traditional line of credit is more open-concluded. There is a set describe menses (i.e., the time in which the borrower tin can withdraw funds), followed by a conversion to an installment loan (at a fixed maturity, typically ten years) at the prevailing habitation disinterestedness loan rate. Whereas, the term of the reverse mortgage is based on the historic period of the homeowners and the borrowing option undertaken. In that location are no required payments for the contrary mortgage until the homeowners vacate their home or pass abroad. Unlike the traditional mortgage but like to a dwelling disinterestedness loan or LOC, the contrary mortgage borrowers are receiving funds. The reverse mortgage is not recommended for less than v years due to the high upfront costs.

The income requirements to qualify for a contrary mortgage are less than a typical mortgage. Before 2011, there were no income requirements and few credit standards. With the incertitude of affectionate home values and increasing default rates, HEMC regulations were changed in 2013. Underwriters at present must check the bidder credit to protect their investment and to make sure that the borrowers have the greenbacks flow to maintain the home at a satisfactory level, as well equally, meet future tax and insurance requirements associated with the house. Like to the traditional mortgage procedure, lenders require borrowing standards based on credit scores, income, other avails, monthly living expenses, and verification of the applicant's credit history. Also, the lender validates the timely payment of existent estate taxes, risk and flood insurance premiums.15

Although the key qualifier is the value of the underlying holding, there are six other requirements for a reverse mortgage (HECM).sixteen

  1. The minimum age for the classified borrower is 62.17

  2. The holding must be endemic outright or with a modest balance owed that can be paid off past rolling this balance into the principal amount from which the monthly cash outflows are based.

  3. The property must be the primary residence of the homeowner. The criterion used is that at least one of the homeowners must live in the home at least 183 days out of the twelvemonth.

  4. Since this is a federal program, the participants must not be delinquent or take defaulted on any federal debt contracts. This includes suspensions, debarments, or excluded participation from other FHA programs.

  5. The holding must meet be either a single-family home, a 1 to 4 unit of measurement dwelling, a HUD-approved condominium or a manufactured home that meets FHA requirements. In that location is a cap on the base of operations amount the factoring value can be applied against regardless of the value of your habitation or your age which is currently set up a $679,650.

  6. All applicants must meet with a certified HECM advisor to make certain the applicants empathise the benefits, likewise as, the risks associated with undertaking a opposite mortgage.xviii

There are several benefits to a reverse mortgage. Primarily, homeowners get to stay in their homes. This assumes that the homeowners take plenty funds to keep the home in good condition, likewise as, keep both belongings insurance and property taxes current. Failure to maintain the dwelling to the standards required or to pay insurance and property taxes void the mortgage contract and requires repayment. A second added benefit is that the payouts made to the homeowner are tax-free. In many cases, the involvement on the reverse mortgage may exist eligible for a tax deduction when the loan is repaid.

A 3rd benefit is a not-recourse clause which states that the homeowner or their heirs cannot be charged more than the value of the dwelling house at settlement. Fourth, Social Security and Medicare entitlements are not affected past the corporeality of the payouts, only Medicaid and other need-based government assist can be affected depending on the corporeality of the payouts during any particular month. To remain eligible for Medicaid or other need-based programs, the homeowner needs to ensure that the funds withdrawn in any ane month do non surpass the programs' eligibility limits. The terminal benefit is that there are no restrictions on how you spend your money.

Reverse Mortgage Payout and Payoff Options

Reverse Mortgage Payout Options

There are several cash menstruation options for payouts within the reverse mortgage construction.

The most common pick and the focus of this paper is the Line of Credit (RM-LOC).19 This option allows for unscheduled payments or installments. The homeowners can draw out funds at any time until the line of credit is exhausted. This option adds flexibility to the borrowers so that money is withdrawn only as needed. The 2nd option is the Tenure Payout in which the homeowner receives fixed monthly payments for as long as at to the lowest degree one borrower lives and continues to occupy the property as a principal residence. The third option is the Term Payout, where the fixed monthly greenbacks-flows are paid out for a specified number of months. The longer the term of the loan, the smaller the payments to the borrower. The adjacent two options are modifications of the offset three options. The Modified Tenure/Line of Credit is a combination of line of credit and scheduled monthly payments for as long as you lot remain in the dwelling house. The Modified Term/Line of Credit is a combination of line of credit plus monthly payments for a fixed period of months selected by the borrower. There also exists a Unmarried Disbursement Lump Sum option, which permits the smallest draw against the disinterestedness value of the habitation and as the name signifies is a one-fourth dimension payout. This is the merely option that permits a stock-still-charge per unit loan. All other options use an adjustable-rate on either a monthly or yearly basis.twenty The final option is the For Purchase option used when the borrower wishes to use the reverse mortgage to downsize and purchase a new home.

Unique to the reverse mortgage, the unused portion of the mortgage primary nether the line of credit options tin can grow over time and it has nothing to do with the abode's value. This rate of growth equals the loan's interest rate calculated monthly. Thus, the funds available for borrowing tin continue to abound over time provided they are not withdrawn. For example, assume the available funds on a line of credit with a 5% interest rate at the starting time of the month equals $135,500 and none of the funds are withdrawn. The available residual volition increase to $136,064.58 (i.e., 135,500 + 135,500 * 0.05/12) after just ane month. The idea behind the growth of principal is that you lot both borrow the money and accrue involvement or you practise not borrow the funds and so the line of credit grows past the aforementioned amount as the borrower who borrowed those funds. The reverse mortgage has no stock-still maturity date. The maturity date is based on the borrowers moving out of the belongings or their passing. Thus, the payout tin can only be estimated by the lender based upon actuary tables constructed from the historic period of the homeowner(s) and the underlying interest charge per unit.

Reverse Mortgage Payoff Options

Just as important as knowing what a mortgage or dwelling house equity loan is, it is every bit of import to know what they are not. Neither a mortgage (traditional and reverse), the equity loan, nor the line of credit transfers the title of the domicile to the lender. The lender only adds a lien to this title. Similar to whatever other secured loan, the property is used as collateral to protect the lender against default. With a traditional mortgage and dwelling equity loan, the borrower is obligated to brand monthly payments until the loan is repaid. Failure to abide past the terms of the underlying contact could consequence in foreclosure proceedings to be started past the lender. Only when a qualifying event occurs is the forced payoff of the total balance due triggered within the reverse mortgage. Any unpaid involvement charges and payouts received by the homeowner are added to the principal that needs to be repaid, therefore the outstanding balance is much larger than the initial borrowing corporeality.

Qualifying events include selling the house; transferring the title of the property to someone else; the borrower(southward) laissez passer away; the borrower(due south) reside elsewhere for longer than 12 months; the borrower(due south) fail to pay property taxes, insurance premiums, or other mandatory obligations on a timely basis; or the borrower(s) neglect to maintain the home. This 12-month grace period permits the homeowner(s) who must seek long-term medical intendance, the pick of returning to their dwelling. Notation that each year the servicer of the loan volition require an Annual Occupancy Certificate to certify occupancy over the past 12 months. Insurance coverage must exist maintained at the aforementioned amount required at the closing of the loan in both amounts and coverage (i.east., take chances, current of air, flood, condo, etc.).

There are 2 pay-off options within the reverse mortgage. The first pick is to sell the business firm and use the proceeds to pay off the loan balance. This can be washed by either the homeowners, their heirs, or the lending institution depending upon how the reverse mortgage was underwritten. If the domicile sale generates more than cash than what is needed to pay off the loan, the excess funds are kept by the homeowners or the homeowner'southward estate. For example, if the survivors owe $150,000 on the loan, but sell the firm for $200,000 they get to keep the extra $fifty,000. But if in that location is a shortfall between the selling price and the corporeality owed, the survivors do the "non-recourse" clause of the mortgage. Thus, they are not responsible for this difference. Using the aforementioned example, if $150,000 is owed, merely the home is sold for only $125,000, the shortfall of $25,000 is forgiven. Thus, 1 of the cardinal benefits of the reverse mortgage is that you lot cannot be charged more than the value of the dwelling house at settlement. The 2d option is to repay the loan through other means and go on the firm. The payoff window is approximately six months subsequently the underlying property is no longer considered the primary residence due to moving or death. The borrowers or their heirs must decide between the two options during this half-dozen-month window.

Costs

Since all mortgage products rely on the underlying value of the property for collateral confronting the loan, they crave that the property exist appraised to determine the amount of the loan the property will support. Under both mortgages (regular and reverse), the borrower may not be required to pay the total closing costs at settlement. These endmost costs, including such things equally a credit report, recording fees, and title commitment, can typically be rolled into the mortgage. This reduces the net funds available. Typically, a home equity line of credit has minimal closing costs, but this is non the case with the line of credit within the reverse mortgage options, which has the same closing costs as any of the other reverse mortgage options. Run across Tabular array two for a sample of typical closing costs.

Tabular array 2. Sample closing costs.

Either type of mortgage tin be insured against default. Inside the traditional mortgage, mortgage insurance is required until a minimum of xx% equity stake is accumulated by the borrower. This mortgage insurance protects the lender confronting the borrower declining to brand timely payments of involvement and main. With the reverse mortgage, the benefits of the mortgage insurance are used to protect the lender and the federal government (i.e., the U.South. Department of Housing and Urban Development—HUD, the federal agency that has oversight of the HECM). Financing this insurance within a reverse mortgage is through both an initial mortgage insurance premium (MIP) and a MIP paid monthly throughout the life of the reverse mortgage. Reverse mortgage default is defined as the failure of the borrower to brand timely payments for taxes and insurance, as well every bit, maintain the property in good condition. A traditional disinterestedness line of credit does not require monthly mortgage insurance.

The initial MIP is the fee that is paid direct to HUD at the endmost of the loan to insure that specific loan within the HECM program. The MIP is used to support iii FHA guarantees: (1) the homeowners cannot "outlive" the contrary mortgage (i.e., the homeowner volition never exist forced out of their dwelling unless there is a default equally described previously); (2) the homeowners or heirs cannot be personally liable if the balance of the loan exceeds the value of the abode at the fourth dimension of sale (i.e., the nonrecourse clause); and (3) the FHA is forced to take over the loan if the lender becomes financially troubled. The initial MIP is fixed at two% of the loan amount.

The types of fees on a reverse mortgage are similar to those institute on a traditional Federal Housing Administration (FHA) mortgage. Although both types of mortgages start with an origination fee, the reverse mortgage fee is typically much larger. This origination fee is compensation to the lender for processing the loan. For a contrary mortgage the maximum fee permitted is calculated equally the greater of $2,500 or the calculated rate. For case, if the claim amount is $100,000, the origination fee is $ii,500 (i.eastward., the maximum of $2,500 versus $2,000 [0.02*100000]). The 2% fee is the percentage charge on loan amounts less than or equal to $200,000. If the value of the domicile is greater than $200,000, limits are 2% of the kickoff $200,000 of home value plus 1% of the remaining balance simply capped at $six,000. For example if the claim is for $500,000, the origination fee would equal the maximum fee of $6,000 (i.e. $4,000 on the start $200,000 [0.02*200000] plus $3,000 on the side by side $300,000 [0.01*300000] which exceeds the cap).21

There is besides a monthly servicing fee, which is bounty to the lender for monthly statements, disbursing loan proceeds, and making sure all the requirements are met. This is a modest fee that is capped at $35/month. On both the traditional mortgage and the reverse mortgage, the service fee can be rolled into the interest rate charged. With the reverse mortgage, these fees could instead be amortized and rolled into the payoff amount. This option would reduce the net amount of the funds bachelor to the homeowner. A counseling fee is a special cost for reverse mortgage applicants. The counselors are tasked with educating the borrowers almost reverse mortgages every bit well as determining if there are any other types of financing they may qualify for.

Line of Credit Reverse Mortgage Investment Strategy

Our assay sets three assumptions for our retiree: (1) age 65 years; (two) portfolio worth $500,000; and (3) owns a firm without a mortgage worth $500,000 that qualifies for a reverse mortgage. The investment strategy with RM-LOC follows two simple withdrawal rules. Start, after a month in which the equity market increases (as measured by the S&P 500 index), retirees withdraw funds from their portfolio. 2d, subsequently a month in which the disinterestedness market place declines, withdrawals are taken from the RM-LOC. In one case the equity market place reverses, then the line of credit and the accumulated involvement is repaid. Note that under a reverse mortgage there is no obligation to repay the line of credit or interest until the death of the mortgagee or the selling of the house.

Although prior research typically assumes a constant withdrawal amount, our analysis relies on a 0.4167% monthly rate (i.e., five percent annually). Our withdrawals are subjected to a maximization rule, i.e., the withdrawal amount will exist the larger of 0.4167% of the original portfolio or the current residual in the portfolio. With our initial portfolio of $500,000, the minimum withdrawal each month is $2,083.33. This maximizes the amount of withdrawal each calendar month. Utilizing a constant percentage helps eliminate sequence adventure.

The analysis covers half dozen historical periods (i/1960-12/1989, 1/1970-12/1999, 1/1980-12/2009, ane/1990-12/2019, 1/2000-12/2019, and i/2005-12/2019) under five portfolio scenarios. Within each period, the initial line of credit is calculated as the product of the habitation value ($500,000) and the principal loading factor (PLF) determined by the mortgage interest rate existing at the offset of each menstruation and the age of the mortgagee. Therefore, the initial RM-LOC changes within each scenario even though the age of our retiree is prepare at 65 since the initial interest rate is fourth dimension-dependent. Since we are trying to determine the merits of this investment strategy going forward, the assay uses the latest HECM Chief Limit Gene Tables (constructive on or later on October 2, 2017) even though all of the scenarios are initiated before 2017. The utilise of historical data gives a representative assay across various interest and equity market conditions.

The initial involvement rate for the most recent scenario (1/2005-12/2019) is based on the ARM for the HECM loans provided by HUD.22 Historical adjustable reverse mortgage rates are recorded from 1989 onward. For all periods before 1989, the base interest charge per unit utilized for the adjustable-rate mortgage rate is the U.S. Treasury Note Constant Maturity 1-yr Yield (H15T1Y).23 Alternatives for this base rate when the adaptable reverse mortgage rate is not available include 1-month LIBOR, 1-year Treasury Bills, six-month Treasury Bills, 10-year constant maturity Treasuries, and the Prime rate. All half-dozen proxies are highly correlated with the adjustable opposite mortgage rates as shown in Table 3. Effigy 2 shows how closely all six potential proxies move with the adjustable reverse mortgage charge per unit. The average deviation between the proxies and the adjustable-rate ranged from a low of 0.52% (standard deviation i.09%) for the 10-year constant maturity Treasury to two.19% (standard departure 0.68%) for the 6-month Treasury Bill. Each of the proxies generates similar results within our analysis with the Prime number charge per unit showing the most variability. Tabular array 3 shows the means, standard deviation, minimum, and maximum differences betwixt the proxies and the adjustable reverse mortgage rates. Margins higher up the base rate of 0.5%, 1%, and 1.five% are likewise tested to estimate the merit of the RM-LOC selection for less creditworthy retirees. The boilerplate margin added to adjustable-charge per unit mortgages over 2005 through 2018 catamenia was 1.29%.24

Table 3. Differences between the adjustable reverse mortgage rate and their proxies.

Inside each of the six periods, 5 different portfolios are analyzed: an all-stock portfolio; a sixty% stock and 40% debt portfolio with and without portfolio rebalancing; and a forty% stock and sixty% debt portfolio with and without portfolio rebalancing. Our proxy for the stock portfolio utilizes the S&P 500 alphabetize, while the debt portfolio utilizes a 50/50% mix between AAA and BBB corporate bonds with maturities of 20 years or longer.25 To illustrate the investment process, we start the discussion with the all-stock portfolio during our most contempo test flow (1/2005-12/2019). Our all-stock portfolio starts with $500,000 invested in an Southward&P 500 index fund.

Without the RM-LOC selection, the first withdrawal in Jan 2005 of $2,083.33 is taken from this portfolio. With the RM-LOC option, the first withdrawal is taken from the RM-LOC and not the portfolio since there was a drib in the market during the previous month of 2.53% (i.east., the S&P 500 dropped from 1211.92 on December 1, 2004, to 1181.27 on January 2, 2005). As noted previously, nosotros apply a 5% almanac withdrawal (0.4167% monthly) of the larger of the original portfolio remainder of $500,000 or the current portfolio rest to maximize our withdrawals. Our initial RM-LOC is $232,350 based on an initial interest rate of 4% (i.e., the actual ARM rate of 4.01% is rounded to the nearest eighth of a per centum). The PLF for a 4% mortgage charge per unit and a 65-twelvemonth-old retiree is 49%. Therefore, the initial RM-LOC is calculated as the home value times the PLF4%,65 less the adjustment for additional financing costs ($500,000 x 0.49 ̶ $12,650). The additional financing costs include mortgage endmost costs26 of $three,300; an origination fee of $iv,450 (origination fee dominion: 2% of first $200,000 financed plus one% of next $200,000 with a maximum upper bound of $600,000. Based on a financing amount of $245,000 ($500,000 x 0.49), the adding is 0.02 x $200,000 + 0.01 x $45,000); and a MIP initial payment of $4,900 (MIP initial payment rule: 2% of the claim amount or 0.02 x $245,000) for a total of $12,650. Withdrawal decision rules with sample calculations for withdrawals, LOC, PLF, and Financed Costs are shown in Tabular array 4.

Table 4. Sample calculations—Withdrawals, LOC, PLF, and financed costs.

Tabular array 5. Investment gains/loses using the reverse mortgage LOC investment strategy all stock ane/2005–12/2019.

The withdrawal during the kickoff month of $2,083.33 plus borrowing fees reduce the LOC to $230,092.56. The extra fees include the borrowing involvement expense of $42.27 associated with financing the closing, origination, and initial MIP fees ($12,650 * 0.0401/12) for the month, plus the monthly MIP of $96.81 (i.e., the monthly charge times the outstanding balance: 1/12 * 0.005 * $232,350) and the monthly servicing fee of $35. In month two, the index increases. Therefore, the withdrawal is taken from the portfolio, but the payback will not occur until the second consecutive monthly alphabetize increase. All borrowing plus involvement costs are carried forward. Two consecutive monthly increases do not occur until February 2006. At this time, the normal withdrawal volition come out of the portfolio forth with enough funds to furnish the LOC. A sample of the cash flows is shown in Table 4.

During this examination period, the average monthly render for the S&P 500 alphabetize is 0.63% (vii.79% annually) with a monthly standard deviation of 3.99%. The wide swings in the monthly returns from the S&P 500 range from a loftier of x.77% occurring on 10/i/2011 through a low of -16.94% on x/ane/2008. During this same period, ARM rates for reverse mortgages averaged three.91% (one.20% standard deviation; vi.61% maximum; and 2.27% minimum).27 The all-stock portfolio analysis shows a slight overall benefit to the RM-LOC selection versus not using an RM-LOC. Although the RM-LOC opportunity shows a slight reduction in the total withdrawals ($five,789) when compared to the no RM-LOC choice, it more than than makes up this deficit with a higher ending portfolio balance differential ($20,153). The net proceeds is $14,364. Of the 180 months within this analysis menstruum, the RM-LOC selection generated positive greenbacks flows in 174 months. Scenarios showing involvement rates increases due to a college lender'due south margin reveal slightly lower net gains of $14,127, $13,890, and $13,653 for the 0.5, 1, and 1.five percentage margin increases, respectively. Thus, higher ARM rates decrease the advantage of the RM-LOC option.

The second scenario utilizes a portfolio consisting of lx% equity and 40% debt with portfolio rebalancing. The rebalancing criteria are based on the residue of the equity account. If the rest drops below 55% or exceeds 65% of the total portfolio's value, the portfolio is rebalanced to the original sixty% equity/xl% debt mix.28 Using the same period (1/2005-12/2019), gains for the RM-LOC pick was slightly lower at $6,749, $half dozen,544, $six,339 and $vi,133 for the base of operations case and 0.5, i, and 1.five per centum add on margins. The number of positive monthly differentials favor RM-LOC at over 96% in all 4 interest rate environments. Again the net gain occurs since that the value gained by the ending portfolio exceeds the slight losses from the withdrawal differentials. The 60% equity/40% debt portfolio without rebalancing also favored the RM-LOC strategy, but at a slightly lower level. The net gains for the RM-LOC strategy are $6,702, $vi,501, $6,300 and $6,098 for the base of operations case and the 0.5, ane, and one.5 per centum add together on margins respectively. The number of positive differential months for all four interest rate cases is 100%. The fourth and fifth scenarios use a lower disinterestedness level and a higher debt component (i.e., xl% equity and lx% debt within the portfolios with and without rebalancing). In this interest charge per unit environment, the RM-LOC choice did slightly worse than the lx/40 mix. The net gain in the RM-LOC option with rebalancing shows lower advantage levels of $3,992, $three,805, $3,617, and $3,430 for the base example and 0.five, i and 1.5 per centum add on margins respectively. The net gain in the RM-LOC option without rebalancing shows relatively the same levels of advantages ($4,184. $iii,999, $3,814 and $3,629 for the base example and 0.5, one and ane.v per centum add on margins respectively). Run across Figures 3 for a summary of the functioning differential of the RM-LOC versus the no RM-LOC options during the 1/2005-12/2019 period.

Figure 3. Gains/losses comparing the LOC and the no LOC scenarios: ane/2005–12/2019.

Note: Positive values bespeak a gain to the LOC Investment Strategy versus the non-LOC Investment Strategy. All five scenarios favor the LOC Investment Strategy based on superior catastrophe portfolio values.

Figure 4. Gains/losses comparison the LOC and the no LOC scenarios: 1/2000–12/2019.

Note: Positive values bespeak a gain to the LOC Investment Strategy versus the non-LOC Investment Strategy. All five scenarios favor the LOC Investment Strategy based on superior withdrawals and ending portfolio values, except for the all-stock analysis where the withdrawal values were lower.

Effigy v. Gains/losses comparison the LOC and the no LOC scenarios: 1/1990–12/2019.

Note: Positive values indicate a proceeds to the LOC Investment Strategy versus the non-LOC Investment Strategy. All scenarios favor the LOC Investment Strategy, except the all-stock portfolio.

Figure half dozen. Gains/losses comparing the LOC and the no LOC scenarios: 1/1980–12/2009.

Notation: Positive values indicate a proceeds to the LOC Investment Strategy versus the not-LOC Investment Strategy. All 5 scenarios favor the LOC Investment Strategy with the dominate factor being college withdrawals versus lower ending portfolio values.

Figure 7. Gains/losses comparing the LOC and the no LOC scenarios: 1/1970–12/1999.

Note: Positive values bespeak a gain to the LOC Investment Strategy versus the non-LOC Investment Strategy. All 5 scenarios favor the LOC Investment Strategy with say-so in both the withdrawals and the catastrophe portfolio values.

All 5 of the different portfolio options (all stock, threescore% equity/xl% debt with and without rebalancing, and forty% equity/60% debt with and without rebalancing) are analyzed over the other five test periods to gain some insight into the performance of the RM-LOC investment option within different disinterestedness market and interest rate environments. As a gage of the investment environment inside each menstruum, the total monthly return from the stock marketplace (as proxied by the S&P 500) was annualized.29 A similar adding was undertaken for the debt portfolio. The average returns in the 1/1960-12/1989 period are 7.05% and eight.73% respectively for the stock and debt indices. For the 60/40 and 40/lx mixed portfolios, the average returns are 5.47% and three.84% respectively. The boilerplate return and standard deviations during all six time periods are recorded in Table 6. Interestingly, the average return for debt dominated equity in two of the test periods (1/1960-12/1989 and 1/2000-12/2019). The advantages of the RM-LOC strategies versus the no RM-LOC strategy are illustrated in Figures three through 8. In all scenarios, RM-LOC produced greater internet cash flows.

Figure 8. Gains/losses comparison the LOC and the no LOC scenarios: one/1960–12/1989.

Note: Positive values indicate a gain to the LOC Investment Strategy versus the not-LOC Investment Strategy. All 5 scenarios favor the LOC Investment Strategy with authorisation in both the withdrawals and the catastrophe portfolio values.

Table 5. Average returns.

Several factors are ignored within our analysis since they merely strengthen the instance for the RM-LOC option, but would add unnecessary complications to the analysis. For instance, the RM-LOC grows if unused which adds potential greater long-run security. But since our analysis includes repayment of the RM-LOC, our RM-LOC is never depleted. Similarly, the size of RM-LOC is dependent on the value of the underlying home. Domicile values are location-specific, i.eastward., homeowners in high valued home markets would take a larger RM-LOC versus depression valued housing locals, again adding potential security.thirty This tin can just add to the advantages of the RM-LOC investment strategy. Even if the withdrawal rule is modified to utilize the maximum of either the original portfolio amount, the electric current portfolio rest, or the RM-LOC, the potential for larger withdrawals would simply come into play when the RM-LOC was larger than the original balance. This cannot occur under the current regulations with our assumed portfolio of $500,000. The maximum reverse loan limit is set on a house valuation of $679,650 times the age and rate specific PLF to determine the RM-LOC. Housing prices could potentially factor into the assay with much smaller portfolio balances or PLFs in very low-interest charge per unit environments for retirees in their 90 s.

The tax effect of the cash flows could besides influence the analysis, just again the bear upon should exist minor. The withdrawals from the RM-LOC are non taxable, while the withdrawals from the portfolio would be impacted by both capital gain taxes and ordinary income taxes. Just since the RM-LOC is replenished periodically from portfolio funds, the portfolio withdrawals are similar with a slight difference due to monthly timing. Thus, in that location should exist little overall issue. Additionally, trading costs are not incorporated into the analysis. At that place is no cost to the RM-LOC withdrawals and as was mentioned previously the withdrawals for the portfolio under the no RM-LOC and the RM-LOC options should take a similar number of transactions with the RM-LOC option slightly less. Over again, strengthening the example for the RM-LOC choice. Finally, the reward of the RM-LOC option can only materialize if the reported gains are greater than the initial cost of undertaking the opposite mortgage which might non be the case for investors with small portfolios.

Conclusion

The key benefit of a reverse mortgage is that information technology allows an elderly borrower/homeowner to stay in their dwelling. Merely this assumes that the homeowner has enough funds to keep the home in good condition, proceed property insurance current, and pays any property taxes. Failure to maintain the home to the standards required or to pay insurance and belongings taxes void the mortgage contract and requires repayment of whatsoever borrowed funds. An added benefit is that the payouts to the homeowner are tax-gratuitous. The interest on the opposite mortgage may too exist taxation-deductible when the loan is repaid, only that is discipline to the existing revenue enhancement lawmaking at the fourth dimension of the repayment. Finally, by repaying the RM-LOC periodically, the retiree tin can take full advantage of any appreciation in the value of the underlying house. Besides guaranteeing a lifetime place to live, the contrary mortgage has merit for helping to manage one'due south portfolio confronting the fluctuations of the equity and debt markets. Notwithstanding, the up-front costs associated with the reverse mortgage add to the unsaid costs of this investment strategy and volition just work for retirees with large portfolios.

1 HECM is a reverse mortgage plan insured past the U.S. Federal Government and available only through an FHA-canonical lender. The HECM Saver Plan was introduced by the FHA in 2010 to provide more affordable options for borrowers who found the closing costs and mortgage insurance rates on the HECM Standard prohibitive. The mortgage insurance premium offered on the HECM Saver was the primal differentiator at only 0.01 percent of the loan amount. The premium on the HECM Standard was 2 percent. In September 2013, HUD eliminated the HECM Saver and Standard options and began offer a single product.

ii See Wade Pfau, "Using Reverse Mortgages in a Responsible Retirement Income Programme." Retirement Researcher. 2/27/2017. https://retirementresearcher.com/using-reverse-mortgages-responsible-retirement-income-program/. This discussion is a small role of his book: How Much Can I Spend In Retirement? From McLean Asset Management Corporation. 2017.

3 Run into for example Forbes (A Look Back at 2015: The 5 About Of import Retirement Planning Changes for 2016, by Jamie Hopkins: https://www.forbes.com/sites/jamiehopkins/2015/12/30/a-wait-back-at-2015-the-5-most-important-retirement-planning-changes-for-2016/#140aaae69041); and Time Money (A surprising proffer for retirement income: http://time.com/money/4517423/retirement-income-contrary-mortgage-surprising-suggestion/).

four See a replay of the video at http://reversemortgagedaily.com/2017/04/09/pbs-programme-takes-deep-dive-into-contrary-mortgages/) link to video https://world wide web.youtube.com/watch?v=ELoUT8x5QpY&feature=youtu.exist.

5 See http://reversemortgagedaily.com/2017/01/04/must-read-reverse-mortgage-financial-planning-manufactures-you-demand-this-yr/. The titles of these 10 manufactures are (1) Reverse Mortgages Will Change Retirement Planning in 2016; (ii) Former Skeptics, These Financial Planners Now Accept Reverse Mortgages; (iii) Why Financial Advisors Must Accept Reverse Mortgages in Retirement Planning; (4) Fiscal Planning Talking Points Every Contrary Mortgage Lender Should Know; (5) Directorate Get Crash Course on Contrary Mortgage Financial Planning Strategies; (6) New Social Security Rules Play Into Contrary Mortgage Retirement Strengths; (vii) Reverse Mortgages Are the Paradigm of Retirement Planning Efficiency; (8) Why I Financial Planner Launched His Own Reverse Mortgage Business concern; (nine) New Rule Offers Opportunities for Contrary Mortgage, Financial Planner Relationships; and (10) Why This AARP Columnist Changed Her Listen on Opposite Mortgages.

6 A historical summary of the reverse mortgage market place can exist found in Guerin (2012) and HUD (2008).

7 Meet https://www.nrmlaonline.org/2019/06/10/complying-with-fhas-hecm-counseling-guidelines-oftentimes-asked-questions.

8 Meet HECM Protocol Affiliate 1. Introduction to Contrary Mortgage Counseling Overview on their roles and responsibilities (pages one–4 through one–10) at https://world wide web.nrmlaonline.org/2019/06/ten/complying-with-fhas-hecm-counseling-guidelines-oftentimes-asked-questions.

9 Although many types of mortgage products be such as fixed-charge per unit mortgages, involvement-only mortgages with a balloon payment at maturity, and adjustable-rate mortgages, the focus of this paper is on the line of credit (LOC). RM-LOC is the all-time reverse mortgage option for apply with an investment strategy.

x The key information on reverse mortgages is taken from the "Essential Reverse Mortgage Factsheet" (http://world wide web.reversemortgage.internet/contrary-mortgage-guide/).

11 Monthly involvement and insurance premiums (MIPs) can besides be added to be financed with a reverse mortgage, but are not typically done for LOC pick.

12 See http://www.hud.gov/offices/hsg/sfh/hecm/hecmhomelenders.cfm for the consummate PLF tables.

xiii Currently three PLF tables exist: a full general tabular array, a special table, and a consolidated table. The general tabular array provides PLFs for borrowers betwixt that age of 62 and 99 matched with interest rates betwixt three% and 18.875% in one-8th increments. The special table uses the aforementioned involvement rate span, merely for ages ranging from eighteen through 61. This is for eligible borrowers with not-borrowing spouses below the historic period of 62, who are eligible to defer the due-and-payable clause upon the decease of the borrower. The PLFs in the special tabular array are much lower than the general table since the lender is at greater hazard of the survivor outliving the disinterestedness value of the home. For instance, at 55, the PLFs drop to 35.5% and thirty.2% at interest rates of 5% and 6% respectively. The consolidated table just combines the two previous tables.

14 Average mortgage rates in 2016 complied past Freddie Mac were three.65%, 2.93%, and 2.87% for 30-year, 15-yr, and 5/one adjustable rates respectively. All the rates assume with 0.5% in points. (See http://world wide web.freddiemac.com/pmms/pmms30.htm for an additional historical listing of rates dorsum to 1980). The lowest reverse mortgage rates offered in 2016 averaged 4.25% with $0 paid in origination fees and iii.ane% with $4,500 paid in origination fees for fixed rates and adjustable rates respectively. The opposite mortgage rates were tied to the closing costs the lender was willing to absorb. (Meet https://world wide web.mtgprofessor.com/news/historical-reverse-mortgage-market-rates.html for a listing of historical reverse mortgage rates).

xv Moulton et al. (2015) recommend the necessary changes needed in the HECM Program to lessen the risk of default. Many of these recommendations are now a role of the HECM Programme such as incorporating minimum credit scores for blessing, limiting the funds that tin can be withdrawn in the offset month, and escrowing tax and insurance funds for weaker applicants to ensure timely payments. See HUD's Reverse Mortgage Insurance Program: Domicile Equity Conversion Mortgages 2017 for more information on the changes to the program since 2000 (p. xx). https://fas.org/sgp/crs/misc/R44128.pdf.

16 AARP (2013) finds borrowers chose the line of credit virtually 66% of the time every bit referenced in Nakajima (2012).

17 Assuming a couple is applying for the reverse mortgage, the spouse can be less than 62 merely the funding is adamant by the age of the younger spouse. The older the couple, the more cash is available to withdraw. If the non-borrowing spouse is less than 62, than there is a significant reduction to the principal limit factors (PLF) which reduces the amount of funds bachelor.

xviii This counseling is used to explicate the financial implications of undertaking a opposite mortgage including the borrowers' obligations, costs, and repayment. Culling options for securing funds, which may be less costly and/or less risky, must besides be discussed. See NRMLA, the National Contrary Mortgage Lenders Clan, at www.reversemortgage.org for more details and the HUD website for additional data: http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/hecm/hecmabou.

nineteen Meet HUD'southward website for more information: http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/hecm/hecmabou.

20 The yearly adjustable mortgage rate is capped at 2% per year and 5% lifetime. The monthly adjustable mortgage rate is capped at 10% per month and 10% lifetime. https://world wide web.aag.com/reverse-mortgage/interest-rates/.

21 The orientation fee can be waived and the costs incorporated into the interest rate charged at the discretion of the lender. The lowest past rates and fees are bachelor from "The Mortgage Professor" (http://themortgageprofessor.refinancetfz.com/).

22 Meet https://www.hud.gov/program_offices/housing/rmra/oe/rpts/hecmsfsnap/hecmsfsnap for a historical listing of all HECM opposite mortgage interest rates.

23 An index published by the Federal Reserve Board based on the monthly average yield of a range of Treasury securities, all adjusted to the equivalent of a one-yr maturity. Yields on Treasury securities at constant maturity are adamant past the U.Due south. Treasury from the daily yield bend. That is based on the closing market place-bid yields on actively traded Treasury securities in the over-the-counter marketplace. Data was downloaded from the FRED Economic Information, Economic Research—Federal Reserve Banking concern of St. Louis at https://fred.stlouisfed.org/series/DGS1.

24 5/ane year adjustable charge per unit mortgage margins over the period ane/2005 through ii/2019 averaged 1.29% with a standard difference of 1.25% (Maximum iii.64%). Source: https://fred.stlouisfed.org/search/?st=mortgage&t=mortgage&et=&nasw=0&pageID=2.

25 Interest rate levels for the Debt Portfolio were obtained from Moody's, Moody'southward Seasoned Aaa and Baa Corporate Bail Yield [AAA and BAA], retrieved from FRED, Federal Reserve Banking concern of St. Louis; https://fred.stlouisfed.org/series/AAA and https://fred.stlouisfed.org/series/BAA, April 2, 2019. The Due south&P 500 closing values were obtained from Yahoo Finance at https://finance.yahoo.com/quote/%5EGSPC/history?period1=-315687600&period2=1554177600&interval=1mo&filter=history&frequency=1mo].

26 Closing costs are outlined in Table 2. For our analysis, nosotros use the post-obit assumptions: $one,980 title insurance; $100 title search fee; $50 document delivery fee; $125 notary fee; $100 document fees; $150 inspection fee; $200 recording fee; $225 endorsement fee; $l credit report; $100 pest inspection; $200 survey; and $20 flood certification.

27 See endnote 21.

28 This rebalancing dominion is similar to other LOC analyses such equally Salter, Pfeiffer, and Evensky (2012).

29 Annualized return calculation equals (ending value/outset value)(1/HP) – one, where the holding period is the number of years within the scenario.

30 For instance, see "Dwelling house Prices in the 100 Largest Metro Areas." Kiplinger (January 2019) https://www.kiplinger.com/tool/existent-estate/T010-S003-dwelling-prices-in-100-peak-u-s-metro-areas/index.php.

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Source: https://www.tandfonline.com/doi/full/10.1080/15214842.2021.2008123

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