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retiring with mortgage debt

4/8/2016

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According to the University of southern California’s Understanding America Study (USA) Financial Management Survey  conducted in April of 2015, forty-three percent of retirees have mortgage debt or a home equity loan and, of those aged 60 and older, almost one third reported having experienced “major financial stress” within the previous 3 years. Twelve percent of those respondents cited a significant health issue as the cause.
It goes without saying that the likelihood of illness increases with age; that a significant health issue can easily lead to major, unexpected medical expenses; and that having to make a mortgage payment during such times can significantly add to the stress.
Retirees with good insurance and a well-funded portfolio may be equipped to handle such a situation with their own resources, but doing so can have some unexpected consequences. Unplanned withdrawals from a tax-deferred account, for example, can push you into a higher tax bracket for the year. Such withdrawals also reduce your portfolio balance, which translates to lower future expected returns.
If your retirement portfolio is limited, an unexpected medical expense could severely deplete it, starting a domino effect that could lead to future financial hardship. If you’re under funded or have no savings at all, such an event could easily lead to a major financial problem. However, if you have significant equity in your home, the judicious use of a Reverse Mortgage may be a viable solution.

​NO MORTGAGE PAYMENT = LESS STRESS

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​It is important to understand that a Reverse Mortgage is first and foremost a mortgage, which is identical in many respects to a traditional mortgage. A key difference, however, is that a Reverse Mortgage allows you far more flexibility in repayment. In fact, the most common use for a Reverse Mortgage is to replace an existing traditional mortgage and thereby eliminate the required monthly payments. Since monthly payments are optional under a Reverse Mortgage, you can choose to pay interest only, once per month, quarterly, annually, fully amortized or make no payment at all (by far the most common choice).

​PAYMENT OPTIONS BEAT SELLING OUT

​Having the option to choose how or whether or to make a mortgage payment can be quite handy. For example, during an unexpected emergency, such as a major illness, you could put a temporary hold on mortgage payments and use current income to handle extra expenses without having to dip into savings. Such options also afford you flexibility at tax time, because any voluntary payments made to the accrued interest on a Reverse Mortgage qualify as deductible home mortgage interest. You can also choose to set up a standby Reverse Mortgage line of credit, which can be tapped when needed without the worry of having to service the debt or the need to deplete other interest-bearing assets and risk pushing yourself into another tax bracket or lowering future earnings potential. Any voluntary payments made to interest or principle would also accrue to your credit line and be immediately available for withdrawal again if needed.

survival of the fattest

​Market downturns can be troubling if you depend upon market-related investments for income in retirement. This is particularly true when those downturns occur early in retirement and withdrawals are taken from the principle balance of your portfolio to make up the difference. The negative effect accumulates over time and may disrupt the expected sequence of returns resulting in early depletion of the asset.
Financial advisors call this problem sequence of returns risk. It’s very important to understand because if you have to sell off too many assets in retirement when they are undervalued, and if there’s an extended period where there is a poor sequence of returns, your assets may end up passing away before you do.
There are various ways to mitigate this problem and, as recent research by a number of highly-credentialed academics has clearly demonstrated,  the judicious use of a reverse mortgage line of credit is an excellent solution. The methodology is simple: tap the line when needed to offset unexpected decreases in portfolio income during slow markets and pay it back when the market is up. The trick is to use the line of credit only when portfolio returns are lower than expected and to pay back the line when they are higher than expected. This strategy is one of the best uses for a reverse mortgage because it is one of the only means of generating income that is not correlated to the market and income from line advances is not taxable.

cash flow versus expected returns

From a Financial Advisor’s perspective, portfolio survival is the essence of retirement planning, and the first task is to balance required cash flow with expected returns. Most people plan for a 30-year retirement and if a market-based portfolio is part of the plan, the manner in which the assets are used is of critical importance in determining whether they will last that long.
Monte Carlo simulations are used to determine the likelihood that a portfolio will survive a certain number of years, and under what market conditions and cash flow scenarios it would be possible. The goal is to maximize both cash flow and returns, but the problem is that neither one of these factors can be known with certainty in advance. Unexpected expenses increase cash flow requirements and market downturns reduce expected returns. When the two occur together the result can be a premature death for your portfolio.
Using a reverse mortgage line of credit to access home equity to cover unexpected expenses or to bolster income during down markets offers an attractive advantage over selling portfolio assets: credit line advances are borrowed money, so they are not taxable. No income tax and no capital gains tax. Contrast this with the sale of portfolio assets, which may incur both types of taxes and reduce the portfolio value with the negative effect of lowering future returns as well.

References:
How Americans Manage Their Finances by Leandro Carvalho, Arie Kapteyn and Htay-Wah Saw.
Promise of Reverse Mortgages and the Peril of Target-Date Fund by Nobel Laureate and MIT Professor Robert C. Merton
Improving Retirement Income Efficiency Using Reverse Mortgages by Wade Pfau, Princeton PhD, CFA & Professor of Retirement Income at the American College
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Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income by Barry S. Sacks, MIT PhD & Harvard JD
​Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions by John Salter, Ph.D., CFP, AIFA; Shaun Pfeiffer; and Harold Evensky, CFP, AIF
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Urban Institute reports that More older adults are retiring with outstanding debt

2/10/2016

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Between 1998 and 2012, the share of adults age 65 and older with household debt increased from 30 to 44 percent. Twenty-four percent of older households had an outstanding mortgage in 2012, up from 16 percent in 1998. The prevalence of other types of debt, including credit card debt, has also grown over time. Moreover, the median debt level among older adults with outstanding debt increased 74 percent in inflation-adjusted dollars over the period, to $24,500. (Excerpt from How Retirement is Changing in America.)

​Source: Health & Retirement Study
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As indebtedness grows at older ages, more families will have to devote part of their retirement income to servicing their debt, leaving fewer resources to meet routine living expenses.

For people facing retirement with an outstanding mortgage, using a HECM to extinguish the monthly payment may enable an earlier and more comfortable retirement.
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The "sandwich" generation

1/26/2016

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If you are struggling to financially support your children and a parent at the same time, you are far from alone. 47% of Americans age 40-59 are in the same situation and are now being referred to as the “Sandwich Generation”. According to the Pew Research Center, about 23% of Americans overall have parents age 65 or older and are either raising a young child or have provided financial support to a grown child in the preceding 12 months. Many within this group are providing financial support to both an aging parent and a child. However, if your parents own their home, they may be able to unlock the equity in their home to create a tax-free income stream by means of a Reverse Mortgage, without creating a monthly liability the way a traditional mortgage would. More details here: www.HBReverse.com
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Can closing costs be eliminated from a Reverse Mortgage?

1/23/2016

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The short answer is no. However, it may be possible to get your lender or broker to pay a portion or even all of them for you. In some cases this can literally mean no net cost to you: you pay nothing out of pocket, nothing is added to your loan balance or deducted from your credit line. The tradeoff will be in the margin you choose as well as the loan balance at the time of closing, which will change the Yield Spread Premium available to the lender.
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“BUT A REVERSE MORTGAGE WILL REDUCE MY ESTATE!”

1/23/2016

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​Conventional wisdom counsels use of a reverse mortgage only as a “last resort” when all other resources have been exhausted. And it is certainly true that if you trade home equity for cash flow you may end up with a smaller estate or no estate at all, especially if you are not careful with the proceeds. But reverse mortgages are not inherently harmful or dangerous and, in some cases, they can have the effect of increasing your estate. The outcome will depend on how they are used. Like a credit card, if used properly, a reverse mortgage can enhance your financial wellbeing and allow you to live a financially safer and more enjoyable life, but it can lead to financial troubles if misused.

USE THE RIGHT TOOL FOR THE JOB

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Think of a reverse mortgage as an asset-management tool to use in income and estate planning. The following steps will help you maximize the benefit:
  • Put it in place early to allow maximum time for credit limit growth.
  • Use a RMLOC gradually in combination with your portfolio in order to keep the outstanding balance in check.
  • If you have a traditional mortgage consider replacing it with a reverse mortgage to improve cash flow and reduce taxable income.
  • Use RMLOC advances in lieu of investment portfolio withdrawals, when it is advantageous for another asset (e.g., don’t sell stocks when the market is down).
  • Always make careful use of RMLOC proceeds. Spendthrifts and RMLOCs are not a good match. Monthly term or tenure payments may be a better approach in such cases.
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IMPROVE YOUR CASH FLOW BY RETIRING YOUR FORWARD MORTGAGE

1/23/2016

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​If you still have a traditional mortgage, you may want to consider replacing it with a Reverse Mortgage. Doing so will immediately improve your cash flow by eliminating the requirement to make monthly payments. You’ll still retain the portfolio leverage the traditional mortgage provided, but you’ll reduce the amount you’ll need to withdraw from your taxable assets for living expenses. Moreover, the reverse mortgage credit limit may be large enough to provide access to additional cash, which can further supplement sustainable withdrawals or add to your net assets. You may also choose to make voluntary repayments to the reverse mortgage balance, which will slow its growth and increase the cash available for future draws. You can stop making payments at any time if cash becomes tight.
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A REVERSE MORTGAGE CAN INCREASE YOUR FINANCIAL WELLBEING

1/23/2016

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​If you’re like most people, you want answers to three basic questions about your financial future:
  1. What can I spend in retirement?
  2. What if I have an emergency like a major health-care issue?
  3. Will I be able to leave an estate?
Adding a reverse mortgage to your retirement planning strategy can address all three by helping to enhance sustainable spending, by serving as an emergency fund, and possibly by increasing the size of your estate, but using the right strategy is key. There are two basic variations:
  • Loan Early - Use Early – This essence of this method is to get a RMLOC early in retirement and begin using the funds immediately in lieu of portfolio draws. This allows your portfolio to grow in the critical early years while at the same time reducing the number of years it must last.
  • Loan Early - Use Late – The strategy here is to acquire the RMLOC early on but to leave it unused while living on your investment portfolio. If or when the investment portfolio is depleted, you turn to the RMLOC for cash to live on. This method gives the RMLOC limit time to grow at the maximum rate for the longest amount of time, potentially providing much more cash than would be available if you waited to acquire the RMLOC only after your savings are gone.
The results of each of these methods will vary according to the manner in which the money is withdrawn (i.e., as a lump sum up front, gradually in monthly payments made to you, in LOC advances taken as needed or any combination of these). G.C. Wagner’s 2013 paper entitled “The Six Percent Rule” directly compared five methods of supplementing portfolio withdrawals with a reverse mortgage and concluded that all five strategies improved sustainable spending rates by an average of sixty percent. This effectively changes the old standard “4% Rule” to a “6% Rule.” Please email info@appletree-ed.com to request a copy of the full research paper.
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RESEARCH SHOWS SAVINGS + REVERSE MORTGAGE OUTPERFORMS SAVINGS + PAID-OFF HOME

1/23/2016

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Even with savings and a paid-off home, many people still face the prospect of running out of money as they age, but recent research shows that strategically combining a Reverse Mortgage Line of Credit (RMLOC) with an investment portfolio can significantly extend the life of your savings. And if you are fortunate enough to enter retirement well-funded, this combination can actually increase the estate you’ll leave your heirs. How to use a Reverse Mortgage to your benefit will depend upon your financial profile:
  • Well-funded – You have enough money to support your expected needs and wants. Adding a RMLOC as a standby or emergency fund provides significant advantages over a traditional HELOC including guaranteed credit limit growth that is not dependent on the value of your home and can even exceed it.
  • Constrained – You have Social Security or a pension and a medium-sized investment portfolio. Your retirement plan is acceptable, but it may require significant lifestyle tradeoffs. You may have no cushion to absorb unplanned events such as higher medical costs or greater longevity. Adding a RMLOC to be used strategically in combination with your investment portfolio or other assets will especially benefit you.
  • Under-funded – You may need cash flow immediately because you have already exhausted all your other resources. You have the greatest need for a reverse mortgage, but if your home is paid off or you have significant equity you can gain a tremendous boost from the use of a RMLOC. The challenge will be to maintain financial discipline and use the RMLOC judiciously to gain the greatest long-term advantage.
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why m.i.?

9/18/2015

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Mortgage Insurance (M.I.) is often the single largest up-front expense involved in acquiring a Reverse Mortgage and is often cited as a reason to avoid getting one, especially when those offering advice mistakenly believe that Mortgage Insurance only benefits the lender. But it is important to understand that it protects borrowers as well, and that M.I. is what makes a Reverse Mortgage possible in the first place.

For the most common type of Reverse Mortgage (a Home Equity Conversion Mortgage or HECM), the insurance provider is the Federal Housing Administration (FHA). Most Financial Advisors understand that if a Reverse Mortgage comes due and the value of the property is less than the amount owed then the FHA pays the Lender the difference. What is not as well known is that if a lender goes bankrupt the FHA steps in to make payments due to borrowers, to guarantee credit lines and to provide funds for advances. Furthermore, FHA Mortgage Insurance guarantees your Reverse Mortgage credit line even if the collateral (i.e., your house) loses value. To illustrate how important this protection is, after the Housing Crash, when lenders were freezing equity lines, lowering limits or canceling them altogether, Reverse Mortgage holders had no such problems. In fact, the limits on Reverse Mortgage credit lines increase over time regardless of whether the value of your home goes up or down, which means you may have access to more funds even when you have no equity left in your home. Furthermore, FHA Mortgage Insurance enables Reverse Mortgage contracts to make the house the only permissible source of repayment for the loan. This means that all other assets you own are safely off limits and your heirs are protected as well.

Another little-known fact is that the FHA is the only Federal Agency that is fully self-funded, which means no tax money is required to run it. Therefore, unlike other government agencies, the FHA must survive on the revenue it generates from the services it provides and the Mortgage Insurance Premiums charged are its only source of income.

So, if you are trying to decide whether or not to obtain a Reverse Mortgage and an expensive Up-Front Mortgage Insurance Premium is causing you to hesitate, remember that you get what you pay for, and in this case, that is lifetime protection for yourself, your estate and your heirs.

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REVERSE MORTGAGES GAIN POPULARITY IN THE SOUTHLAND

8/1/2015

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Existing Reverse Mortgages by County

Los Angeles
Riverside
Orange
San Diego
San Bernardino
23,720
8,783
7,656
8,665
6,626
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    ABOUT THE Author

    Kevin Michael Melody has been a Mortgage professional in Southern California since 1990. Now based in Huntington Beach, Kevin assists buyers and sellers of residential property with all their financing needs, with a special emphasis on "Old School" personal service. He uses his more than two decades of experience in mortgage lending and residential Real Estate to take his clients from start to finish on any type of transaction. Sellers can take advantage of his intimate knowledge of financing to pre-screen buyers and offer creative solutions for self-employed individuals, business owners and otherwise well-qualified buyers who may not fit traditional lending guidelines. He also assists homeowners looking to refinance to a better rate or lower payment, consolidate debts or get cash for home improvements, and even families whose homes are underwater can be helped under Fannie Mae's Home Affordable Refinance Program (HARP) and Freddie Mac's Open Access Relief Refinance for owner-occupied single-family homes, condos, manufactured homes, and 2-4 unit residential income properties, as well as vacation homes, rentals and investment property. Kevin is a proud veteran of the United States Air Force, and author of the 2001 book "What Lenders Don't Want You To Know."

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