The Consumer Financial Protection Bureau (CFPB) issued a new report warning seniors against using a reverse mortgage as an income bridge to delay collecting Social Security benefits. While the report rightly points outs the potential risks of reverse mortgages, it demonstrates little understanding of the nuances of Social Security claiming strategies and overstates the typical cost of a reverse mortgage in today's marketplace.
But new rules issued by the Department of Housing and Urban Development will increase the costs of reverse mortgages in the future and reduce the amount of equity seniors can borrow through the government-backed Home Equity Conversion Mortgage (HECM) program. The new rules take effect Oct. 2, 2017, but will not alter the terms of existing reverse mortgages.
A reverse mortgage allows homeowners age 62 or older to tap some of the equity in their home through a lump sum, a line of credit or regular monthly payments. The debt is subject to interest payments, mortgage insurance premiums and monthly servicing fees plus origination and closing costs. No repayment is due until the owner leaves the home permanently or dies and the loan repayment amount can never exceed the value of the home.
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The report uses the example of a 62-year-old single woman who uses income from a reverse mortgage to delay claiming Social Security benefits until her full retirement age of 67. It calculates she would receive $29,640 more in cumulative Social Security benefits during her lifetime if she claims a monthly benefit of $1,300 at age 67 rather than collecting $910 per month at the earliest possible claiming age of 62.
The report assumes the woman borrows $54,600 of her home equity through a reverse mortgage — the cumulative value of the $910 in monthly Social Security benefits that she did not collect during the five years between the ages of 62 and 67 — and repays the reverse mortgage after seven years which the report said is the typical length of a reverse mortgage loan.
"In seven years, when the borrower turns 69 and terminates the loan, the reverse mortgage loan costs will be $31,900, approximately $2,300 more than the lifetime amount of money ($29,640) gained from an increased Social Security benefit if the consumer lives to age 85," the report said. If, instead, she chose not to repay the loan during her lifetime, the costs would be about $178,000 if the consumer lived to age 85.
Time for a reality check.
"The analysis selects a Social Security deferral strategy that provides very little benefit to the individual and compares the present value of increased Social Security costs to the future value of reverse mortgage costs," said Jamie Hopkins, co-director of the Retirement Income Program at the American College of Financial Services.
Married couples have the most to gain from coordinating their Social Security claiming strategies, Mr. Hopkins noted. By having the spouse with the larger benefit delay claiming until age 70 when Social Security benefits are worth the maximum amount and having the other spouse claim benefits earlier to generate cashflow for the household, a married couple can increase their joint lifetime Social Security benefits — including surviving benefits for the remaining spouse — by $100,000 or more.
For single people, their only choice is when to collect benefits with the amount tied to their initial claiming age. If a single person lives to normal life expectancy, it doesn't matter whether they claim reduced benefits early or full benefits at normal retirement age. The trade-off is actuarily fair. The big payoff comes from delaying beyond full retirement age as benefits increase by 8% per year up to age 70. But delaying benefits until 70 is likely to be more valuable for married couples, where one spouse would receive a larger survivor benefit, compared to singles whose benefit dies with them.
"The report makes numerous inaccurate statements about reverse mortgages and disingenuously increases the costs by ignoring lender credits, making the product appear much more expensive than it is in practice," Mr. Hopkins added.
Retirement income expert Curtis Cloke, founder of Thrive Income Distribution System, agreed that the report's fuzzy math presents a distorted view of reverse mortgages.
"Depending on the total household income, the reverse mortgage creates cash flow without tax while the Social Security benefit could create tax," Mr. Cloke noted. "Taxes were completely ignored in this paper."
Mr. Cloke said he would not recommend a reverse mortgage as a standalone strategy solely to delay Social Security. Rather, he would suggest that a homeowner apply for a reverse mortgage as soon as possible at age 62 to take advantage of growing line of credit.
"Setting up the line of credit now allows the homeowner to take advantage of future roll-up values," Mr. Cloke said. That would allow homeowners to tap the reverse mortgage for a variety of short-term loans such as delaying Social Security, taking cash flow in a bad market year to preserve an investment portfolio or to satisfy short-term liquidity needs, such as buying a car or replacing a roof. In each case, he would recommend repaying the loan, noting that interest payments are tax deductible.
"Often, retirees own assets in their portfolios such as CDs, bonds or structured notes that may have specific maturity dates that do not match perfectly with the liquidity needs of their life," he explained. "The ability to have access to a reverse mortgage line of credit while waiting for the maturity date to pay off the loan balance may actually enhance the total net worth, taxes and optimization of the use of a reverse mortgage."
It is unclear how the new reverse mortgage loan limits and higher up-front borrowing costs that take effect Oct. 2, 2017, will affect future retirement income planning strategies.
(Questions about new Social Security rules? Find the answers in my new ebook.)
Mary Beth Franklin is a certified financial planner.
