Savings & Investing

Improve reverse mortgages to help
fix retirement

Jun 20, 2016
By John Sweeney

The retirement readiness of millions of Americans could be improved by tapping their home equity through a reverse mortgage. A reverse mortgage can equitize an asset that would otherwise be left to heirs and can bring cash flows into the present so retirees can utilize them during their lifetime. The American financial system lacks credible reverse mortgage providers that can integrate the reverse mortgage discussion into retirement income plans and help retirees turn their home equity into income during retirement.

The challenge

Planning for income in retirement is challenging owing to multiple uncertainties (longevity, inflation, sequence of returns, healthcare, market returns, etc.). Research suggests that 55% of Americans1 are not on track to maintain their lifestyle in retirement because they have inadequate savings and their expectations for retirement need to be recalibrated: e.g., they need to retire later, they underestimate longevity and they fail to anticipate rising healthcare costs in retirement.

The number one concern of retirees is outliving their assets.2 Retirees also don’t want to be a burden to their children. Tapping home equity in order to fund retirement helps to address both issues.

  • 91% of pre-retirees aged 50 to 65 state that they want to live in their own homes in retirement.3 Of that group:
    • 49% want to stay in their current homes, and
    • 38% want to move to new homes.

Today, the most common way for retirees to equitize home equity is to sell the home, downsize to a smaller (and typically less expensive) home, and invest the proceeds. For retirees who wish to remain in their homes, they can take a home equity line of credit (HELOCs) when extra cash is needed (e.g., for an emergency or when the market performs poorly) but banks stopped issuing lines of credit during the 2008-09 crisis and new HELOCs being issued are still 72% below the highs from 2006.4 Credit for the retired homeowner appears to dry up just when they need it most.

The reverse mortgage enables the homeowner to tap a portion5 (~60%) of the value of their home and receive either a lump sum payment or a stream of income. Reverse mortgages can be used at the start of retirement to improve the success of the retirement plan or they can be used as a “standby” source of income in retirement, accessed when needed.

A solution

The reverse mortgage industry in the United States is small and suffers from a bad reputation. After the financial crisis, many of the large US banks withdrew from the market, leaving it fragmented and without a clear leader.

Often sold as a product of last resort to low income people with few other options, reverse mortgages can be packaged as part of a more holistic retirement income plan and targeted to mass affluent customers as a way to improve the success of their retirement plans—and to higher net worth customers as an estate planning strategy. The American retirement industry needs a credible firm to:

  • Build a retirement planning capability that incorporates a reverse mortgage as part of a holistic income plan;
  • Simplify reverse mortgage loan origination; and
  • Integrate mortgage servicing into retiree cashflow management capabilities.

Conditions and assumptions

Size of the market

There are 46 million Baby Boomer households in the US that hold in total $3T in home equity (as of 3Q 2011).6 Of those:

  • 11 million have sufficient liquid assets to maintain their standard of living in retirement. There is an opportunity for these homeowners to use a reverse mortgage to pull cash forward and use it for financial and estate planning purposes.
  • Another 11 million have liquid assets but those assets may not be sufficient to withstand negative events in retirement. There is an opportunity for these homeowners to use reverse mortgages to pull cash forward to improve the outcome of their retirement plans.
  • 24 million do not have adequate assets. 7

 

Size of the home equity market 1990 - presentNumber of loansInitial principal limitHome value
Originated in Total 740,000 $114B $166B
Outstanding 582,000 $92B $136B

Governmental support

Most reverse mortgages are insured by the Federal Housing Administration (FHA) through its Home Equity Conversion Mortgage (HECM) program. The insurance guarantees that:

    • Borrowers will be able to access their authorized loan funds in the future (subject to the terms of the loan):
      • Even if the loan balance exceeds the value of the home; or
      • If the lender experiences financial difficulty.
    • Lenders are guaranteed that they will be repaid in full when the home is sold, regardless of the loan balance or home value at repayment.
    • Borrowers or their estates are not liable for loan balances that exceed the value of the home at repayment.

    Should governmental support for reverse mortgages go away, it would be difficult to build a significant business around this product if borrowers felt like they could be removed from their homes during their lifetimes or if their heirs were saddled with a large payment upon settlement of the estate.

    Key implementation steps

        • Build a retirement planning tool that incorporates reverse mortgages into the cash flow projections. Ideally, this tool would be used by investment advisers serving mass affluent customers planning for retirement.
        • Build a simple mortgage origination capability that drives down costs by integrating with retirement income planning capabilities.
        • Incorporate payment streams into retirement income management accounts to allow for:
          • Recurring distributions from the reverse mortgage
          • Periodic distributions during periods of market underperformance or significant income requirement (e.g., health event or major home repair).

      Improve reverse mortgages to help fix retirement

      Hear John F. Sweeney share his ideas on how to improve reverse mortgages to help fix retirement.

      John F. Sweeney

      About the author 

      John F. Sweeney
      Executive Vice President, Retirement and Investing Strategies, Fidelity Investments

      John Sweeney is executive vice president, Retirement and Investing Strategies for Personal and Workplace Investments (PWI), a unit of Fidelity Investments. Fidelity Investments is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing and other financial products and services to more than 20 million individuals, institutions and financial intermediaries. Mr. Sweeney is responsible for the thought leadership provided to Fidelity’s representatives and retail clients, and is regularly quoted in the press and on television. He has testified before the United States Senate Committee on Finance on the retirement readiness of American investors.