How Much Will Reverse Mortgage Leave for Heirs?

This question seems to be a fear of many seniors who are caught in a conflict between wanting to provide a bequest to their family when they die and wanting to enhance their own lives in the meantime.

The fact is, however, that the Federal Housing Administration’s reverse mortgage program, known as the home equity conversion mortgage or HECM, is designed to serve both objectives.

While an HECM necessarily reduces the home equity that becomes available to the borrower’s estate, in most cases it does not absorb all the equity.

Furthermore — and this is the critical point — seniors have discretion with regard to the amount of home equity that is used to meet their own needs and the amount that is retained for their heirs.

Unfortunately, in most cases, seniors don’t use that discretion, because they have no idea how their selection of HECM draw options will affect the equity that will remain for their heirs.

Recently, however, my Kosher HECM calculator, found on my website, was upgraded to generate that information. The calculator now estimates the equity that will accrue to the borrower’s estate for any combination of draw options the senior selects.

This is illustrated by a hypothetical senior of 65 who owns a debt-free home worth $400,000.

In case 1, I assume she has enough income to meet her recurring needs but is anxious about the possibility that she may face heavy medical expenses down the road.

She selects a credit line that grows at the same interest rate as the HECM so long as it is not used.

After 10 years, the line has grown to $345,000, at which point she owes only $10,000, a sum of her HECM settlement costs plus 10 years of interest.

Parenthetically, this use of a HECM as an insurance policy against unknown contingencies has got to be the best bargain available in financial markets. If the senior never has to use the policy, all her home equity except the inconsequential amount she owes on the HECM will go to her heirs. And if she does need to draw on the credit line to pay her bills, no one will question the decision.

In case 2, it is assumed that the senior has significant unmet needs right now and draws the maximum amount of cash available to her at closing, which is $123,960. (A second installment becomes available to her after 12 months, but I assume she has no need for it and allows it to grow unused).

This sizable advance results in a significant loan balance, which reduces but does not eliminate the home equity that will become available to her heirs. If she dies after 30 years, her estate will owe $581,000 but it will realize $1.3 million on the sale of the home.

In case 3, it is assumed that the senior must supplement her income and elects to draw the maximum monthly tenure payment of $1,061. In this case, her equity is higher than in case 2 in the early years but it becomes lower as the years go by.

In case 4, she draws a payment of $3,961 for five years only. Her equity is the lowest of all the cases but it remains positive.

The calculator works just as well when the senior selects a combination of options. To illustrate that point, case 5 assumes an upfront cash draw of $30,000, a monthly tenure payment of $500, and a credit line of $81,000.

The figures for home equity are, of course, estimates.

They are based on the assumption that the property will appreciate at 4 percent a year, which has been the average over a very long period and is the figure used by the Department of Housing and Urban Development in setting draw amounts.

Obviously it may not apply to any shorter period or to any particular house. And of course, equity varies with the senior’s mortality, which is why we programmed the calculator to compute the results for every year until age 100.

Forecasting the future is always subject to error, but forecasts based on the best possible information will turn out better than those based on hunch and surmise.