This month's Journal of Financial Planning
has an academic article on a strategy to increase portfolio withdrawal rates by using a reverse mortgage line of credit as an alternative source of spending cash during bear markets.
Increasing the Sustainable Withdrawal Rate Using the Standby Reverse Morgage
The gist of the strategy is tapping into home equity when the portfolio value drops 20% below a straight-line "glide path" representing the value of the portfolio across time that would allow the client to fully fund a real withdrawal rate for each year in a 30-year retirement horizon.
If the portfolio value returns to the glide path value, the reverse mortgage balance is paid off from the portfolio.
- This study investigates maximum real sustainable withdrawal rates (SWRs) for retirement plans that incorporate the use of standby reverse mortgages (SRMs). The SWR is defined as the maximum real withdrawal rate with a minimum 90 percent plan survival rate for a 30-year retirement horizon.
- The SRM evaluated in this study is a Home Equity Conversion Mortgage (HECM) reverse mortgage line of credit that is established at the beginning of retirement and is used for retirement income during bear markets. Outstanding loan balances are repaid from the Investment Portfolio (IP) in bull markets.
- Monte Carlo simulations were used to estimate the success of the SRM strategy at various real withdrawal rates for a client who has a $500,000 investment nest egg and $250,000/$500,000 in home equity at the beginning of retirement. The $500,000 nest egg is split into a 60 percent stocks and 40 percent bonds IP and a six-month cash reserve.
- Retirees who begin retirement in a low interest rate environment (2.3 percent yield on 10-year U.S. Treasury bond) with competitive lending terms and significant home equity relative to the IP stand to benefit the most from an SRM strategy. Interest rates and the size of the initial line of credit relative to the IP are the two factors that are shown to have a significant impact on the SWR for the SRM distribution strategy.
- Results pertaining to the low interest rate and current lending environment indicate that a 5.0 percent SWR is attainable for the SRM strategy when home equity is at least 50 percent of the IP at retirement. The SWR for the SRM strategy is estimated to be as high as 6.75 percent for retirees in the low interest rate environment where home equity is equal to the IP at the beginning of retirement.
The following table shows the author's estimates of higher SWR's using the strategy.
SWR= safe withdrawal rate,
SRM= standby reverse mortgage,
PLF= the percent of home equity at retirement date that is available in the form of a line of credit, using HUD formulas based on age, home value and LIBOR interest rates.
HE cushion= home equity value relative to starting portfolio value
There's no free lunch, of course. The author's simulations show median wealth at the end of 30 years is lower using the SRM strategy, I assume in large part because some simulation runs resulted an unpaid reverse mortgage balance at the end of retirement.
Table 2 also shows that higher interest rates have negative effects on the strategy. I see three reasons for this. One is when the interest rate is higher the maximum credit line as a percentage of available home equity is reduced under HUD formulas . This reduces the dollar value of the cushion available for the strategy. The second effect would be that a payback at the end of the bear market period will be greater. The third, which is not covered in the article or the table, is that home values and the available home equity may tend to fall when interest rates rise or the markets go in the tank.
Using the reverse mortgage calculator here Reverse Mortgage Calculator
at today's interest rates a 62-year-old with $500,000 in home equity would spend $14,000 in up-front origination costs to establish a $228,000 line of credit. This translates to a line of credit equal to 45% of the available equity.
Is anyone approaching reverse mortgage eligibility (age 62) persuaded that today's environment of low interest rates and rising home values makes today a good time to establish a reverse mortgage line of credit?
At 54, this isn't an option for me. And I surely won't be recalculating my ER SWR based on a hope and wish that this strategy might be available in the same form in 8 years. Even if I was eligible, I think I would evaluate the RMLOC as a form of insurance for long-term care rather than a strategy for increasing my annual spending baseline.