It’s no secret that reverse mortgages have had a rough start. I believe the ultimate reason for this is not that reverse mortgages were fundamentally different in the past, and that the HECM of today is “not your grandfather’s reverse mortgage”. Clearly, there have been meaningful updates to the HECM’s features and protections over the years, but it is still conceptually the same thing. And it’s still the most underappreciated financial tool I’ve seen in 19 years of financial planning, so selling it like it’s different now than in years past – a strategy I see a lot in the industry – is not working.
I believe the problem is that thinking of debt as a useful tool, which it very much can be, will always challenge people’s intuitions. This is the fight the reverse mortgage industry needs to address.
Here’s an example that illustrates what I mean.
Imagine a 75-year-old couple planning to celebrate their 50th anniversary with kids and grandkids. They plan a big and memorable trip, and they budget $50,000. They distribute the $50,000 they need from a $500,000 brokerage account to cover the cost. That account is now $450,000.
Assuming this trip is affordable for them, does anyone fault the couple for taking this trip to celebrate the legacy they built? I sure hope not. If that’s not a worthy use of investments at that point in life, what is?
They take the trip, and everyone has a fantastic time. Over the next decade, the entire family mentions it often with fond memories. They have no regrets.
Let’s say over that same decade, the remaining $450k brokerage account doubled (this is 7.2% annualized, which is not unreasonable) to $900,000. Indisputably, they are less wealthy 10 years later to the tune of $100,000, for having gone on the trip. If they’d left the $50,000 in the account instead of celebrating their anniversary, the account would have become worth $1M.
Is this clearly true? Yes. Should we always avoid spending money for this reason? Of course not. It’s just something we must consider when we spend money. And this concept is always relevant, not just in retirement.
To Spend or Not to Spend…
Here’s where it gets interesting. What if they’d borrowed the money instead? Whether it’s with a reverse mortgage or some other loan tool isn’t relevant here – it’s the “loan” that causes our intuitions to scream.
In this alternate scenario, they borrow the money and never make a payment on the balance, allowing it to increase. Most loans don’t work this way, but such a thing is possible with a reverse mortgage. And what if that balance over those same 10 years accrues at 7.2% (also reasonable) from $50,000 to $100,000?
This $100,000 debt balance makes us all squirm. It just feels different than the first scenario where the trip was paid for by selling the assets, right? It’s debt! There’s interest! The bank took $100,000 of my equity even though I only borrowed $50,000. They’re stealing my home equity!
But fundamentally and importantly, from a net wealth perspective, it isn’t different than selling the assets and giving up the future growth. The balance sheet doesn’t care.
Yes, by borrowing the money 10 years ago, they now have a $100,000 liability. However, they kept their investments intact, which are $100,000 larger than if they’d sold them 10 years ago.
This concept is so fundamental in grasping the value of reverse mortgages that I refer to it as “The Most Important Thing”.
On a side note, notice that nothing taxable has happened by borrowing against an asset, whereas selling investments often comes with tax consequences. This concept is precisely why almost all permanent life insurance policies have loan features built right into them. It’s a brilliantly simple way to save significant money on taxes.
Let’s get back to our couple who celebrated their 50th wedding anniversary. Let’s examine their financial situation ten years later at age 85. Their $1M home has a reverse mortgage with a $100,000 balance. Is this a problem? An emotional one, probably. Most people would feel like they’d made a terrible mistake by borrowing $50,000 when ten years later they owe $100,000.
But as strong as those emotions are likely to be, the problem is only emotional. They have $900,000 of home equity. And the investment portfolio is $100,000 larger (plus the tax savings inherent in this strategy) because they didn’t touch it for the anniversary bash a decade ago.
The strategy of borrowing against assets rather than selling them is one that wealthy families and businesses have been using for hundreds of years. Their planners and accountants understand this basic concept and employ it regularly. And, with no small effort from well-meaning financiers, actuaries, and accountants, it’s been made readily available for the masses through reverse mortgages, and we tend to look down our noses at it like it’s somehow beneath us because it’s “debt”.
So, in my experience, the strongest headwind HECMs face is the public’s misunderstanding of this fundamental issue. Debt, like fire, is a powerful tool. Yes, it can be destructive if not understood and respected, but it can also add tremendous benefits to our lives. In fact, nearly all the trillions of dollars in wealth that exists as home equity would not be possible without the use of debt somewhere along the way. That’s strong evidence that debt can be, and quite often is, used constructively.
In a nutshell, a HECM simply makes home equity liquid. Yes, there’s interest involved, but that’s fundamentally the same thing as selling portions of investments and missing out on the future growth. Again, your balance sheet doesn’t care. It’s how money works and has worked nearly since its inception.
We must address this more competently and more regularly. Once financial planners and the public become comfortable with this concept, the HECM then sells itself. It makes an illiquid asset (equity in your residence) liquid, and when it is seen this way and with a proper understanding of debt as a valuable financial tool, no one in their right mind would prefer a large portion of their wealth remain illiquid when making it liquid is an option.
Guest Column by Brady Mullen
