Academic journal article ABA Banking Journal

Closing the GAP: How Banks Can Help Older Adults Use the Equity in Their Homes to Provide Another Source of Retirement Funding

Academic journal article ABA Banking Journal

Closing the GAP: How Banks Can Help Older Adults Use the Equity in Their Homes to Provide Another Source of Retirement Funding

Article excerpt

Today, the three traditional sources of retirement income--savings, pensions and Social Security benefits--aren't always enough to enable older adults to live the retirement they imagined. This leaves many hardworking people financially ill-prepared for retirement.

The numbers tell a very sobering tale: Studies show that 14 percent of U.S. residents age 65 and older have zero retirement savings. The median retirement account balance for near-retirees is just $14,500. And the average baby boomer has less than $50,000 in retirement savings.

As a result, home equity is becoming increasingly important as a component of older adults' retirement plans. In fact, home equity as a percentage of home value rose from 39 percent in 2008 to 54 in 2014. The estimated aggregate value of home equity owned by older adults is $3.96 trillion, just 1 percent below its peak of $4 trillion in the fourth quarter of 2006. One way for older adults to access this equity as a retirement asset is through a reverse mortgage. Recent changes to the Federal Housing Administration's home equity conversion mortgage (HECM) program have made reverse mortgages a more viable option. The Reverse Mortgage Stabilization Act of 2013 has helped protect consumers and create a more sustainable program. Changes include new limitations on the amount that can be drawn at closing and in the first 12 months, a required financial assessment on each application to help ensure that borrowers can continue to meet their obligations as homeowners, an adjusted mortgage insurance premium (MIP) to more accurately price for risk and added protection for non-borrowing spouses.

In addition to helping protect consumers, these changes reduce headline risk, ensure the stability of the program, broaden its appeal and have spawned newly designed products with more options to meet the needs of older adults. For example, Reverse Mortgage Funding LLC (RMF) has an innovative, low-cost HECM option that eliminates nearly all closing costs.

All of this has caused financial advisors to take a fresh look at reverse mortgages, and more are recommending HECM loans for some clients as part of their retirement strategies.

According to the Center for Retirement Research at Boston College, "Accessing home equity will become increasingly important in a world where retirement needs are expanding; people are living longer and facing rapidly rising health care costs; the retirement system is contracting; Social Security replacement rates are declining; and employer-provided pensions have shifted from defined benefit plans to 401(k)s where balances are modest. Reverse mortgages offer a mechanism for tapping home equity for those who want to stay in their home."

It all began in 1989, when the HECM program was created as an FHA-insured loan option for homeowners age 62 and older. It allows borrowers to access a portion of their home equity as income tax-free cash, as long as the home is the borrower's primary residence. Funds may be taken as a line of credit, monthly tenure or term payments, a lump sum or a combination. There are no monthly mortgage payments required, but the borrower continues to be responsible for property taxes, homeowners insurance and property maintenance in order for the loan to remain in good standing. Interest is added to the loan balance, and the balance grows over time.

A FIECM is a home-secured debt, payable upon default or a maturity event, and must be repaid when the last borrower (or protected nonborrowing spouse) sells the home, moves out or passes away. It is a non-recourse loan, so the borrower cannot owe more than the home's value when the loan is repaid.

How can it work for retirement funding? A HECM line-of-credit option can serve as a rainy-day fund, or a standby line of credit to be tapped when invested assets are underperforming, to avoid withdrawing assets and help portfolios last longer. …

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