In order to solve large-scale challenges, it is important to remember that innovation – the creation of new solutions – does not only involve technology, but it can also come from changes in thinking, in mindset, and applying old ideas and tools anew. Especially when tackling difficult issues like the growing retirement challenges in America today, we need to open our minds to marshal all sources of ideas, approaches, perspectives and tools to better understand and be able to attack the problem.
In order to do that, we need to regularly refresh our thinking by uncovering and challenging assumptions and long hidden deep biases. It is here that we should be aware of the “expertise” trap of relying strictly to older embedded solutions and applications from our experience. Closed mindsets rely on what’s worked in the past and tend to do mental shortcuts of immediately deflecting or dismissing other ideas and thereby missing the opportunity to uncover new and better client solutions. An open mindset recognizes that things change. Products can be applied differently or mixed with other tools or approaches to produce new outcomes.
With the scale of the Retirement Crisis in America and growing complexity of other areas like HNW family and business wealth, rethinking the traditional financial planning process and the creative use of financial tools becomes a growing priority. The Institute for Innovation Development will be starting an article series focusing on different financial products and financial planning processes to explore areas that may benefit from a re-examination. We decided to start with an interview of Institute member, Harlan Accola, National Director, Fairway Independent Mortgage Corporation, who is on a passionate mission to build awareness of the need to rethink reverse mortgages. Armed with facts and a ton of research, he argues for reverse mortgages as a key financial planning tool that can substantially address the growing Retirement crisis and change the retirement experience for untold millions of clients.
Hortz: Why do you feel so strongly that reverse mortgages can play such a fundamental role in addressing the retirement crisis and change the outcomes for millions of retirees?
Accola: There is over $7.1 Trillion in home equity owned by seniors over the age of 62! Let’s put the size of this potential solution in context – there are currently over $1 Trillion in car loans outstanding, over $1 Trillion in student loans, and in excess of $800B in credit card balances. The truth is that using the $7 trillion in home equity MUST be used in order to give baby boomers the retirement they need and want. Boston College Center for Retirement Research professors wrote a book called Falling Short – the Coming Retirement Crisis and What to Do About It, where they demonstrated that the statistics are clear – without home equity we cannot get the baby boomers to the finish line even at normal 80s life expectancy!
The bad news is if they don’t do it as a preventive measure, they will be forced to do it in their 70s, 80s or 90s when they may not even qualify or be forced into a scenario that is not as effective as in an advanced retirement planning strategy. The evidence and research clearly show that the best time to get a reverse mortgage is when you are earlier in retirement.
Here is the bottom line – everyone has 3 buckets of wealth. Bucket 1 is their guaranteed monthly income that comes from Social Security, Pensions or Wages. Bucket 2 is their nest egg that is invested and managed by financial advisors for the most part. And Bucket 3 is the client’s home which is a significant part of baby boomers’ net worth.
If all three of these buckets are managed as one holistic group, the chance of all the money lasting longer goes up dramatically. Bucket 3 MUST be a part of the overall planning process beyond just turning to bucket 3 as a “loan of last resort” when all other buckets are depleted or become less when one person passes away.
Hortz: Can you discuss the scope and nature of that research on reverse mortgages and share with us a few top resources or studies that you recommend advisors should read?
Accola: The interesting thing about the hesitancy of the financial planning profession is that they have largely ignored the solid research done by those respected in their industry. It all started with Harold Evensky and John Salter at Texas Tech University Personal Finance Dept. Their findings were published in 2012 in the Journal of Financial Planning detailing using reverse mortgages to mitigate sequence of returns risk.
Then the Sacks brothers published a study showing the coordinated strategy of using money from bucket 2 and bucket 3 at the same time to make bucket 2 portfolio longevity increase. But by far the most comprehensive research was done by Dr. Wade Pfau, Professor of Retirement Income from The American College who developed the RICP designation (Retirement Income Certified Professional). He not only reviewed the past studies but also did thousands of his own Monte Carlo scenarios. He then published books on Reverse Mortgages detailing all of his findings and tying all of the research together.
Pfau’s books contain irrefutable evidence that home equity that becomes liquid with a reverse mortgage virtually guarantees three things. First – more cash flow; second – lower income taxes; and third – most surprisingly, a larger net worth and thus a greater legacy to pass on to the next generation. Despite a reverse mortgage decreasing equity in bucket 3, bucket 2 gains cash and longevity which increases overall wealth.
Hortz: With so much research and proven applications for retirement planning, why the negative connotations and resistance by both retirees and advisors?
Accola: ALL products can alternatively be good or bad depending on how it is sold or applied; anything can be misused. Unfortunately those stories consistently take center stage and reverse mortgages have some lingering negative connotations.
Let’s review two very bad things that happened in our industry. First, because the product came out with an FHA guarantee in 1988 with no income or credit guidelines, many people with very little in reserves and bad credit jumped on board. While no payment is due until the end, it is required that the borrower continues to pay taxes and insurance. Many early borrowers did not have the means to pay taxes for the life of the loan so lenders were forced to foreclose on senior borrowers – in many cases – and widows in their 70s, 80s and 90s. Thousands of foreclosures got lots of negative media exposure.
The second major black eye on the industry was the problem with underage borrowers (under the age of 62). If a spouse was qualified in their 60s or 70s, but they had a younger spouse, they were allowed to borrow by taking the younger spouse off title. He, or she, was not protected when the older spouse died and had to pay off the loan or move. Widows were kicked out of their homes after their husbands died because a wrong decision was made.
Because of these things, now new rules and legislation from HUD requires borrowers to qualify and prove they are willing and able to pay taxes and insurance for their expected life time. AND if they have an underage spouse, they are required to be part of the loan and they are guaranteed to stay in the home for as long as they wish after the older spouse passes.
But perhaps one of the biggest issues that still haunts many baby boomers is the memory of the depression. Their parents and grandparents told them about the need to have a home FREE AND CLEAR without a mortgage. Long before federal protections on both forward and reverse mortgages, many people lost their homes in the 1930s. This depression era thinking has not gone away and is rooted in heavy emotion devoid of facts. Regardless it is a very strong cultural “rule” that your house should be paid off as you get older and should stay that way. That stigma must be addressed with facts appropriate to the 2000s.
Hortz: Are reverse mortgages suggested even for high net worth and very wealthy families? Are there any unique applications for them?
Accola: A reverse mortgage is a bit like a Swiss Army Knife that has a different tool for many different uses. There are many things a reverse mortgage can accomplish for those who have “plenty of money”. By far the biggest advantage is paying off their existing mortgages – which is better with a reverse mortgage than using money from a 401(k) or other investments to pay it off. That way you can utilize more of your funds for the investments. Run the numbers; it is a very inefficient use of retirement funds or income to pay off low rate mortgages!
Sequence of Returns risk in retirement is a big concern and a reverse mortgage line of credit can be used so money is drawn from the market only when it is up. Since the reverse mortgage line of credit is a great buffer asset, it allows you as the advisor to keep all the assets fully invested focused on longer-term gains. When market downturns come, the RM serves as a cash account. Tax free withdrawals from a reverse mortgage are a popular way to pay taxes on a Roth conversions or NUA taxation. When it comes to delaying social security, paying health and long-term care costs, or doing tax free gifting to family members, a reverse mortgage works much better than IRAs or other taxable funding options.
The 2017 Tax Cuts and Job Act left a wonderful pathway for decreasing taxes on qualified retirement funds. Interest on Acquisition indebtedness is the only interest that is still left as deductible. But because of the new larger standard deductions, most retirees have lost the ability to get an itemized tax deduction on their interest. However since you can pay interest optionally with a reverse mortgage- you can stack the interest and only pay it when it substantially exceeds your standard deduction, and get the full benefits of the interest deduction.
New home purchases come into play as well. When clients move to their retirement home, they only have to pay about half down to eliminate their payment for the rest of their lives. So if they are downsizing, extra money will become assets under management, and if they are upsizing, no money will need to be taken out of their assets.
Pigeon holing reverse mortgages as a loan for the 80- or 90-year old widow who is broke is a very unfair label that needs to change. It will cause your clients to lose millions of dollars in opportunity costs and potential tax savings over their retirement years.
Hortz: What is your best advice to advisors that they should reconsider on how to use reverse mortgages in retirement planning?
Accola: My concern for advisors is that the ground-breaking research on reverse mortgages and strategically using them in a wealth management plan is so overwhelmingly evident that there are may actually be legal implications to NOT talking to your client about properly using them. Jamie Hopkins, an attorney in the financial planning world, specifically wrote an article in Investment News about the dangers of ignoring something that increases wealth and retirement income AND decreases risk at the same time. Why would you not want your clients to know about this?
We all have a right to our own opinions, but no one can make up their own facts. Adoption rates for reverse mortgages in early retirement planning are way too low. We ask advisors to put their own personal biases and past prejudices aside. The research is that cut and dried on this subject. The benefits to the client is the main reason to integrate reverse mortgages early into the retirement planning process.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.