January  4, 2022

A major weakness of the HECM reverse mortgage program is that it is a stand-alone. Potential synergies from integrating HECMs into retirement plans have been ignored. This article provides one illustration. It shows how a HECM can be combined with an annuity to neutralize the high risk that accompanies a high-yield asset portfolio.

Consider Mary who is retiring at 62 with a house worth $500,000 and an asset portfolio worth $1 million, 75% of which is in common stock. Her financial advisor has recommended that she rebalance her asset portfolio so that common stock accounts for 25% of the total, an action that would reduce the risk of a major shortfall at the cost of a lower expected return.

As an example, on a portfolio that is 75% common stock and 25% fixed-income, the median rate of return calculated over many past 10-year periods going back to 1926 was 9.5%, but in 2% of the 10-year periods, asset value declined by 2.7% or more. That is a bad case that Mary does not wish to risk. By shifting her portfolio to 25% stock, the bad-case would rise from minus 2.7% to positive 2.8%. The cost of that reduction in risk is a decline in the median return from 9.5% to 6.1%.

A HECM would allow Mary to retain the 75% stock portfolio with its higher expected return while neutralizing the bad case if it occurred. It does this with a HECM credit line which is accessed only if needed to retain the spendable funds that would occur with the median rate of return.

Chart 1 shows the spendable funds that will be available to Mary over her life assuming median rates of return at 5, 10 and 15 years, with annuity payments deferred for the same periods. The chart indicates that when risk is ignored, the longer deferment period generates more spendable funds.

Chart 2 shows what happens to the spendable funds directed to Mary if the initial payment calculated at the median rate is followed by a drop to a bad-case rate (in this example, the 2^nd percentile rate) that is maintained until the annuity kicks in. While the 15-year deferment worked best using median rates of return, in the bad case most users would prefer a shorter period.

Chart 3 adds access to a HECM credit line in the bad case. The credit line is drawn on to supplement spendable funds that fall short of the amounts that would be available if the median rate of return materialized rather than the bad case. Spendable funds are stabilized with both 5-year and 10-year deferment periods. With the 15-year deferment, however, the stabilization ends after about 8 years when the credit line is fully used. If Mary’s home equity was $600,000 rather than $500,000, the credit line would be large enough for full stabilization of the 15-year option.

The bad case is a very low probability event. In the likely event that it doesn’t occur, the HECM credit line could be used for any other purpose, or not used at all. Maintaining an unused credit line is costless.