How to prepare for retirement emergencies

In a recent article in US News and World Report, Emily Brandon discussed three common emergencies that the elderly often encounter and how to prepare for them. However, she left out the best possible resource available to senior homeowners for meeting two of the three types of common emergencies: a HECM reverse mortgage.

This article will describe how a HECM can deal with major home or car repair expenses, and with the depletion of retirement savings by living too long.

• Major home or car repair

Expenses for these purposes are seldom a surprise, but those who don't prepare for them, or procrastinate in dealing with them, may be startled on the day the roof drip becomes a flood, or the cranky automobile engine won't start at all.

Brandon suggests the maintenance of a cash fund that would cover expenses for a period of six to 12 months, which is OK - for renters. For homeowners, a HECM credit line has several advantages.

First, assuming the owner has significant equity in her home, a sizable credit line becomes available when the HECM loan is closed. A long saving period is not needed because the reverse mortgage is based on the saving that the owner did in earlier years. For example, an owner of 65 with a debt-free house worth $200,000 could obtain a line of about $100,000 fully available at closing, at a cost of about $8,500.

The second advantage is that this unused line of credit grows at the interest rate on the reverse mortgage, currently 3 percent to 5 percent, whereas a cash fund will earn 1 percent of interest or less. While the cost of the reverse mortgage credit line grows at the same rate as the line, the dollar growth in the line is much larger than the growth in cost because the initial line is much larger.

If the $100,000 line sits unused for ten years, for example, it will be about $83,000 larger whereas the cost will be about $7,000 larger.

• Runaway medical expenses

Medical emergencies sometimes strike out of the blue with no prior warnings, while the amounts involved are not predictable and can be catastrophically large. Insurance is the only way to deal with this problem, and I have nothing to add to what Brandon says on the subject.

• Outliving your savings

Aside from sickness and disease, this is the greatest hazard faced by those retiring now, and the most difficult to guard against. Brandon's suggestion that retirees delay taking Social Security until they are 70 makes sense for retirees with a long expected life, but it won't come close to filling the retirement income shortage if the major source of that income, withdrawals from their savings, drops to zero.

In the typical case, the retiree who defers taking Social Security until age 70 will receive a monthly payment about $1,000 higher than if they had begun at age 62. But if the retiree has been drawing $4,000 a month or more from savings that run out, the knowledge that they would have been in even worse shape had they not delayed taking Social Security is not very helpful.

To provide meaningful protection, the increment in Social Security benefit would have to be added to retirement savings from the very beginning, at age 70, rather than spent. Adding $1,000 a month to retirement savings would increase total savings at age 85 by about $200,000 - and for a retiree drawing $5,000 a month, the period before savings depletion would be moved forward three to four years. The problem is that this would require a discipline that very few retirees have. The fact is, I never heard of anybody doing it.

The HECM credit line is the ideal vehicle for insuring against the risk of outliving your money. As noted above, it grows at the mortgage rate so long as it is unused. When the need arises, the senior can begin drawing on the credit line, or she can use the line to purchase a monthly tenure payment that will continue for as long as she lives in the house. She can also do both, purchasing a tenure payment with part of the line while retaining the rest for special occasions. If the need never arises, the unused equity in the house passes to the borrower's estate.

• Contact Jack Guttentag via his website at mtgprofessor.com.

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