The Lemon Fool

I'm approaching retirement (maybe in year - I will be in my mid fifties) and I've been reading about how US researchers (Wade Pfau etc) talk about using home equity as part of an asset allocation strategy in draw-down.

Now I know that they are talking about reverse mortgages (equity release), but the principle of being able to tap into home equity in the early years of retirement to mitigate sequence of returns risk sounds interesting to me.

What's to stop me taking out the biggest offset mortgage for the longest period I can and leaving it fully offset with savings, ready to draw on in periods when other investments do badly? (It could also act as an emergency fund)

Has anyone else considered this? Any drawbacks I'm missing?

Cheers,
P

FredBloggs wrote:I'm not really sure why you wouldn't simply use the money to provide some cover for a rainy day rather than use it to offset a loan? The rainy day money will just sit there to tide you over for a year or two while the market recovers from one of its periodic slumps. Unless I am being really dim (quite possible) I don't know what you aim to achieve with an offset loan.

Taking out a mortgage and fully offsetting it would be cash neutral initially.
I was assuming being fully invested with little or no cash reserve as such (which could be argued to be a drag on performance). The borrowing facility would only be used while markets were down (in the same way a cash reserve for a non-fully invested person might be).

I guess there are bank setup costs and mandatory monthly life insurance costs to consider.

iain123 wrote:I guess there are bank setup costs and mandatory monthly life insurance costs to consider.

Yes - setup costs are one thing to consider.

Is life insurance mandatory these days?

Thanks,
P

FredBloggs wrote:

pbarne wrote:

FredBloggs wrote:I'm not really sure why you wouldn't simply use the money to provide some cover for a rainy day rather than use it to offset a loan? The rainy day money will just sit there to tide you over for a year or two while the market recovers from one of its periodic slumps. Unless I am being really dim (quite possible) I don't know what you aim to achieve with an offset loan.

Taking out a mortgage and fully offsetting it would be cash neutral initially.
I was assuming being fully invested with little or no cash reserve as such (which could be argued to be a drag on performance). The borrowing facility would only be used while markets were down (in the same way a cash reserve for a non-fully invested person might be).

What I can't understand though, is that you need the cash to fully offset the mortgage. So I fail to see any benefit to you. Spend some of the cash and you pay interest on the mortgage as it will no longer be fully offset. Perhaps you need somebody cleverer than I am to express an opinion. Sorry.

I understand your point. This approach only makes sense if you believe the research that shows that you get a better outcome by paying interest on the borrowed money and waiting for the market to recover, than to sell equities when they are down. In an ideal situation (benign sequence of returns) you would never use it.

However it does also have a side benefit as a very liquid emergency fund for any other unexpected large bills.

If I understand correctly, you are suggesting getting an offset mortgage for as much as possible (x% of the value of the house) and then using the cash from the mortgage to "offset", so the mortgage is costing you the minimum (with whatever requirements your lender has re minimum loan, insurance etc.).

This available cash is effectively liquidity in the property, which you propose to use as an alternative to e.g. a savings cash buffer, which would have the disadvantage of having to save up for, as well as poor returns vs equity over your planned retirement period. In the event of an early market downturn and less-than-expected returns, you would draw on the mortgage, hoping to pay it off when equities recovered.

This is certainly an option, but you take on a risk that the market falls further, for longer than you planned, and the mortgage costs start to snowball, especially if interest rates are not under your control. This creates an increasing cost on a dwindling cash supply unless you reduce expenditure, which even then, interest rates may hurt you before there is a chance to recover. Other than that, I don't really see a downside to it, provided you've built enough fat into the plan to survive minor hiccups and intra-year cash flow variations.

A halfway house may be to set up the offset mortgage (whilst working and able to get the best interest rate deal) but also plan to save a % of the normal cash buffer, model your different scenarios to see how you'd be affected by say, a 50% dividend cut and a 50% equity fall, lasting for 1 year and taking 6 years to recover? (Other scenarios are available!)

You will presumably be looking to build the cash buffer over time, at least so as to provide options should future mortgage deals not be as tempting...

vrdiver wrote:If I understand correctly, you are suggesting getting an offset mortgage for as much as possible (x% of the value of the house) and then using the cash from the mortgage to "offset", so the mortgage is costing you the minimum (with whatever requirements your lender has re minimum loan, insurance etc.).

This available cash is effectively liquidity in the property, which you propose to use as an alternative to e.g. a savings cash buffer, which would have the disadvantage of having to save up for, as well as poor returns vs equity over your planned retirement period. In the event of an early market downturn and less-than-expected returns, you would draw on the mortgage, hoping to pay it off when equities recovered.

This is certainly an option, but you take on a risk that the market falls further, for longer than you planned, and the mortgage costs start to snowball, especially if interest rates are not under your control. This creates an increasing cost on a dwindling cash supply unless you reduce expenditure, which even then, interest rates may hurt you before there is a chance to recover. Other than that, I don't really see a downside to it, provided you've built enough fat into the plan to survive minor hiccups and intra-year cash flow variations.

A halfway house may be to set up the offset mortgage (whilst working and able to get the best interest rate deal) but also plan to save a % of the normal cash buffer, model your different scenarios to see how you'd be affected by say, a 50% dividend cut and a 50% equity fall, lasting for 1 year and taking 6 years to recover? (Other scenarios are available!)

You will presumably be looking to build the cash buffer over time, at least so as to provide options should future mortgage deals not be as tempting...

Yes, your summary of the strategy is correct - thanks for putting so succinctly!

I would definitely go for the mortgage prior to retiring to get the best deal - hence why I'm considering now.
In the event of the markets being down for an extended period and the loan starting to snowball, downsizing would be an option.

I've tried modelling against a 60:40 equity/bond portfolio for a 2000 (UK) retirement and the results look encouraging.

You would need to take into account the costs of setting up the mortgage, - not least legal fees, lender's valuation fee, possible lender's admin fees depending on mge product.

You would also then likely be exposed to rising mge int rates which can't be too far ahead.

I’m about 2-3 years from FI and I plan to make my offset mortgage a big plank of my strategy.

It will have around 20 years to run at that point but for the first 10 years of FI, my plan is to start with it fully offset (ie zero interest costs). Then in years where my asset portfolio value falls, I will not take anything from the portfolio but will draw down some of my offset, holding ~10% in reserve to cover the next few years of interest costs.

Obviously if interest costs are punitive this won’t work but I’ve done a fair bit of analysis and I think this can really help with sequence of returns risk in that first decade. The nasty scenario (which isn’t impossible) would be global equities (and dividends) down, U.K. rates up, GBP up.

My total offset is around 30% of the value of my home (and about the same proportion of my asset portfolio value). In the Armageddon scenario we’d obviously need to downsize, cut spending or return to work.

I have down precisely this.

In anticipation of retirement (currently 54) I remortgaged last year.

Currently my £420K Barclays mortgage is split 160K Repayment (15 year term) and 260K Interest Only. By the end of this month this borrowing will be fully offset by 250K in cash and 170K in Cash ISA

My plan is to disinvest from my Lifestyle Fund investments in my SIPP at 55 (TFLS).

Put the cash into my mortgage offset account and then re-invest the CASH ISA into Vanguard funds, thus retaining my equity exposure

This only works because Barclays allow Cash ISA's to offset mortgages, AFAIK they are the only lender that allow this. I am (will be) paying a slightly higher interest rate for this facility, but it is costing me nothing at the moment as I am paying no interest.

My plan is to retain the offset facility, not to draw down to spend but to use as a future funding vehicle as I want to develop/build my own house.

Regards

Pheid

Pheidippides wrote:I have down precisely this.

In anticipation of retirement (currently 54) I remortgaged last year.

Currently my £420K Barclays mortgage is split 160K Repayment (15 year term) and 260K Interest Only. By the end of this month this borrowing will be fully offset by 250K in cash and 170K in Cash ISA

My plan is to disinvest from my Lifestyle Fund investments in my SIPP at 55 (TFLS).

Put the cash into my mortgage offset account and then re-invest the CASH ISA into Vanguard funds, thus retaining my equity exposure

This only works because Barclays allow Cash ISA's to offset mortgages, AFAIK they are the only lender that allow this. I am (will be) paying a slightly higher interest rate for this facility, but it is costing me nothing at the moment as I am paying no interest.

My plan is to retain the offset facility, not to draw down to spend but to use as a future funding vehicle as I want to develop/build my own house.

Regards

Pheid

Thanks Pheidippides. Did you have any debate or discussion with Barclays as your lender about your intention to do this after retirement?

Also, I’m a bit confused as to why you would want to offset your mortgage with ISAs. Given that cash offsetting your mortgage is ‘earning’ tax free interest already, isn’t that a waste of the ISA wrap? Or did you just want to use the ISA capacity up to secure it for future use, planning to switch to Equities as you describe above?

pbarne wrote:What's to stop me taking out the biggest offset mortgage for the longest period I can and leaving it fully offset with savings, ready to draw on in periods when other investments do badly? (It could also act as an emergency fund)

Fortunate to have reached a position this year where isa shares + cash savings = offset mortgage, with 11 years until maturity and (by happy coincidence) access to pension in the same year. I have no intention of paying it off early while I am still working, chiefly because I am paying base rate + 0.5%, as you say those savings are available to draw on in emergency times (or more likely, buying cars for offspring and horses for Lady M ). The important number to keep in mind
if you do take out a big mortgage is the residual equity in your home, ideally you want enough to downsize comfortably if you end up spending all that borrowing ...

I intend to do something very similar to protect my first 10 years of early retirement drawdown from sequence of returns risk.

The rough logic behind this is to leave an amount of mortgage unpaid, let’s say £100k, at the point of ‘retirement’ (55) but to have an equivalent amount in a savings account which is offsetting the debt. This means I won’t be paying any interest on the outstanding debt.

My aim is to start with a 60/40 equity/fixed income portfolio. Over the course of the first 10 years of drawdown, the hope is that there is no major adverse market event. If that’s the case then our portfolio grows, withdrawals are taken from the fixed income allocation, the portfolio shifts over time from 60/40 towards 80/20 (rising equity glide path - see Wade Pfau https://retirementresearcher.com/use-ri ... etirement/ ). Over this period of time the value of the house rises and the effects of inflation erodes the size of the debt in real terms.

In the event of some kind of catastrophic market event which impacts both equities and fixed income, I have the option to stop withdrawing from the portfolio completely and to drawdown from the savings account. This means that I’d start to pay interest but only on the amount of cash I withdraw annually. Let’s say £30k pa so that means I could keep this up for 3 years. In the event that both equities and fixed income are tanking, there’s a good chance that the economy is tanking and therefore a good chance that BoE rates are dropped to stimulate the economy. That means I’m likely to be borrowing into an environment where mortgage rates are dropping.

My mortgage is currently an interest only mortgage with First Direct which also provides my current account and savings account so any cash I have is already offsetting my mortgage which is equivalent to getting a savings rate on cash of ~2%. Everything else is in SIPPs and ISAs. I have until age 67 to pay off the mortgage. 3 years before I hit 55 which gives me access to the SIPP. Just in the process of dialling down my asset allocation from 70/30 to 60/40 to reduce volatility. Just working out my tax optimised drawdown strategy.

There’s lots of US FIRE material out there which discusses the use of HELOCs (Home Equity Line of Credit) to help manage sequence of return risk. There are not many UK banks which offer HELOCs (possibly Barclays). Where they are offered they tend to be at higher interest rates compared to prime mortgage interest rates with low loan to equity ratios. UK offset mortgages offer a route to access this concept at low cost but this needs to be planned in properly during the run in to retirement.

Degsy

Spet0789 wrote:Did you have any debate or discussion with Barclays as your lender about your intention to do this after retirement?

Nope - I wanted to do IO and Barclay forced me to take part ( ~1/3) on repayment. The term was to my normal retirement age of 67. My career plans were not discussed

Spet0789 wrote:Also, I’m a bit confused as to why you would want to offset your mortgage with ISAs. Given that cash offsetting your mortgage is ‘earning’ tax free interest already, isn’t that a waste of the ISA wrap? Or did you just want to use the ISA capacity up to secure it for future use, planning to switch to Equities as you describe above?

The ISA wrap is to reinvest my TFLS into. A future low cost loan is also valuable

Regards

Pheid

Makes sense.

Pheidippides wrote:I have down precisely this.

In anticipation of retirement (currently 54) I remortgaged last year.

Currently my £420K Barclays mortgage is split 160K Repayment (15 year term) and 260K Interest Only. By the end of this month this borrowing will be fully offset by 250K in cash and 170K in Cash ISA

My plan is to disinvest from my Lifestyle Fund investments in my SIPP at 55 (TFLS).

Put the cash into my mortgage offset account and then re-invest the CASH ISA into Vanguard funds, thus retaining my equity exposure

This only works because Barclays allow Cash ISA's to offset mortgages, AFAIK they are the only lender that allow this. I am (will be) paying a slightly higher interest rate for this facility, but it is costing me nothing at the moment as I am paying no interest.

My plan is to retain the offset facility, not to draw down to spend but to use as a future funding vehicle as I want to develop/build my own house.

Regards

Pheid

What would happen in the event of Barclays going bust? Is there any chance with the ISA's over £85k you could end up owing the mortgage, but losing the Cash ISA's?

paulnumbers wrote:

Pheidippides wrote:I have down precisely this.

In anticipation of retirement (currently 54) I remortgaged last year.

Currently my £420K Barclays mortgage is split 160K Repayment (15 year term) and 260K Interest Only. By the end of this month this borrowing will be fully offset by 250K in cash and 170K in Cash ISA

My plan is to disinvest from my Lifestyle Fund investments in my SIPP at 55 (TFLS).

Put the cash into my mortgage offset account and then re-invest the CASH ISA into Vanguard funds, thus retaining my equity exposure

This only works because Barclays allow Cash ISA's to offset mortgages, AFAIK they are the only lender that allow this. I am (will be) paying a slightly higher interest rate for this facility, but it is costing me nothing at the moment as I am paying no interest.

My plan is to retain the offset facility, not to draw down to spend but to use as a future funding vehicle as I want to develop/build my own house.

Regards

Pheid

What would happen in the event of Barclays going bust? Is there any chance with the ISA's over £85k you could end up owing the mortgage, but losing the Cash ISA's?

It depends precisely how the offset is structured at your bank. I can’t speak specifically for Barclays but usually (and in the case of my provider, First Direct) the answer is no. Your savings would be netted against your mortgage balance so are economically 100% protected.

This is obviously a problem for future financial planning as your offset will effectively have benn converted into a normal mortgage with no ability to re-draw the capital but you won’t have lost money, only flexibility.

But given the amount of capital banks now have junior to senior unsecured creditors this is a real Armageddon scenario.

Degsy67 wrote:In the event of some kind of catastrophic market event which impacts both equities and fixed income, I have the option to stop withdrawing from the portfolio completely and to drawdown from the savings account. This means that I’d start to pay interest but only on the amount of cash I withdraw annually. Let’s say £30k pa so that means I could keep this up for 3 years. In the event that both equities and fixed income are tanking, there’s a good chance that the economy is tanking and therefore a good chance that BoE rates are dropped to stimulate the economy. That means I’m likely to be borrowing into an environment where mortgage rates are dropping.

What about a prolonged inflationary crisis where all your long duration assets get taken behind the woodshed, interest (and mortgage) rates rise sharply, along with large and continued increases in your cost of living? The sort of thing that no one is forecasting or preparing for...

IMO there is a danger that a future turns of events, where the nature and market implications of the crisis look nothing like the last one, leave the method being discussed here looking "too clever by half" versus having taken a more prudent initial approach that perhaps required a lower withdrawal rate and/or longer period in employment to build a larger pot of money.