Using a HECM reverse mortgage to neutralize portfolio risk

Using a HECM reverse mortgage to neutralize the high risk that comes with a high yielding asset … [+] Portfolio


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

Consider Mary, who retires at 62 with a $ 500,000 home and a $ 1 million financial asset portfolio, 75% of which is held in common stock. Her financial advisor has recommended that she realign her portfolio of assets so that common stocks make up 25% of the total, a move that would reduce the risk of a larger deficit at the expense of a lower expected return.

For example, for a portfolio that was 75% common stocks and 25% fixed income, the average return over many periods from 10 years to 1926 was 9.5%, but over 2% of the 10 year periods the asset declined by 2.7% or more. This is a bad case that Mary doesn’t want to risk. Shifting your portfolio to 25% stocks would increase the bad case from minus 2.7% to a positive 2.8%. The cost of this risk reduction is a decrease in the median return from 9.5% to 6.1%.

A HECM would allow Mary to hold onto the 75% equity portfolio with its higher expected return while neutralizing the bad case should it happen. It does this with a HECM line of credit that is only accessed when needed to hold on to the funds to be spent that would result in the median return.

Figure 1 shows the funds to be spent that will be available to Mary for the rest of her life assuming an average return of 5, 10, and 15 years with annuity payments deferred for the same periods of time. The graph shows that if the risk is neglected, the longer grace period will generate more funds to be spent.

How the grace period for a deferred pension affects the funds to be spent in retirement

Figure 2 shows what happens to the funds disbursed to Mary if the initial payment calculated using the median rate declined to a worst case rate (in this example the 2nd In the worst case scenario, users prefer a shorter deadline.

The effect of a below-expected return on financial assets

Diagram 3 adds access to a HECM line of credit in the worst case. The line of credit is drawn on to add funds to be spent that are less than what would be available if the median return, rather than the bad case, occurred. The available funds are stabilized with both 5 and 10 year grace periods. With the 15-year deferral, however, the stabilization ends after around 8 years when the credit line has been fully exhausted. If Mary’s home equity was $ 600,000 instead of $ 500,000, the line of credit would be large enough to fully stabilize the 15-year option.

A reverse mortgage line of credit used to mitigate downside risk

The bad case is an event with a very low probability. In the likely event it doesn’t, the HECM line of credit could be used for other purposes or not at all. Maintaining an unused line of credit is free.

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