NEW YORK (MainStreet) — Imagine having a retirement safety net that cost nothing to maintain and actually grew as you aged rather than getting smaller. How would that affect other parts of your financial plan?
The other day we talked about getting a reverse mortgage line of credit now, but holding it in reserve for later. Key benefits: You'd lock in today's low interest rate but face no interest charges until you started withdrawing cash five, 10 or 20 years later. You get a bigger credit line when rates are low, making this a good time to apply. As you aged the line of credit would get larger, like a safe, fixed-income investment with a tax-free yield far higher than you'd find in bank savings or a CD. And if you never needed this fallback fund, you could leave all your home equity to your heirs, having lost only the startup costs.
That growth feature is especially valuable. The initial line of credit is based on the applicant's age, the amount of home equity and the mortgage rate fixed when the loan is approved. Afterward, the credit line grows at a rate tracking prevailing mortgage rates. So a line of credit that started just under $100,000 might grow to nearly $400,000 in 20 years, assuming mortgages remained at a modest 5%.
That 5% is modest by mortgage standards — most investors' mouths would water at the prospect of seeing what is essentially a fixed-income investment growing that fast. It would grow even more if rates were higher.
For a 62-year old, the youngest you can be to take out a reverse mortgage, the prospect of having a $400,000 reserve fund at 82 — when other retirement savings could be skimpy — would be wonderful.
Of course, this is not found money. Using the line of credit would reduce the equity in the home, and there are other ways to get at that money, such as downsizing to a cheaper home. But many people like the idea of staying in their home for the duration. And by doing so and relying on the line of credit set up years earlier, you can protect yourself from the whims of the housing market.
So how would that affect other parts of your retirement scheme?
For one thing, it could allow you to take more risk with your other investments. Instead of moving the bulk of your holdings into short-term bonds and cash in a bid for safety, you could leave a sizable portion in stocks. With the line of credit available to get you through a stock market slump, you could continue to hope for the higher returns stocks generally provide over the long term.
With the credit line in reserve, you also might feel free to draw more cash from other assets. Instead of spending 4% a year, you might spend 5% or 6%.
Or you could sell off some holdings to fund another safety net, such as a deferred annuity, also known as longevity insurance. That way, you'd reduce the odds of having to tap your credit line, but the credit line would be there just in case.
The point is, whatever mix of strategies you settle on, they'll work better if you set up your reverse mortgage line of credit when interest rates are low. You'd get a bigger line of credit and lose less to interest after you start using it. With the economy starting to take off, interest rates could start to rise. So this opportunity may not last very long.
— By Jeff Brown for MainStreet