Forbes: Forward vs. Reverse Mortgages in Retirement
Using a reverse mortgage to refinance an existing mortgage will create more financial flexibility for fixed-income retirees, according to Dr. Wade Pfau, professor of retirement income at the American College of Financial Services and a member of the Funding Longevity Task Force, in a new piece at Forbes.
“The general idea is that a reverse mortgage used primarily to refinance an existing mortgage creates more flexibility for distribution needs from the investment portfolio by removing a fixed expense from household budgeting in the pivotal early-retirement years,” Pfau writes. “During pre-retirement, it is common to pay off the mortgage more slowly in hopes that investment returns will outpace the borrowing costs on the mortgage.”
Pfau advises against that slow forward mortgage repayment, however, because it can create additional risk. “[…] Distribution needs heighten the retiree’s vulnerability and exposure to market volatility,” he says.
Refinancing an existing forward mortgage with a reverse mortgage would still allow a borrower to make payments if they choose to, which can build the accompanying line of credit. However, if a regular payment is not made, then the borrower doesn’t run the risk of foreclosure, as happens with a traditional mortgage.
“Voluntary payments can be made strategically when markets are performing well and then stopped when it is necessary to sell assets at a loss to make payments,” Pfau details.
This can primarily act as a way for a senior to avoid sequence of returns risk, but the growth rate on the reverse mortgage loan balance can still exceed the interest rate on the pre-existing mortgage, Pfau warns.
“One must balance the trade-offs between the increased flexibility and reduced cash flows to be supported earlier in retirement against the possibility that the final legacy value for assets could be hurt if the Home Equity Conversion Mortgage (HECM) loan balance is not repaid for many years,” Pfau says.
Also offered are different scenarios in which a senior keeps their forward mortgage into retirement, illustrating what happens when a HECM line of credit is opened and tapped at different stages, which Pfau emphasizes can illustrate for people how maintaining a traditional mortgage can, “compare with using a HECM to refinance it.”
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