Deciding on Right Reverse Mortgage

With home equity conversion mortgages — the HECM is the Federal Housing Administration’s reverse mortgage program — there are both fixed-rate and adjustable-rate versions.

Adjustable rate HECMs can adjust annually with a maximum rate increase of 5 percent, or monthly with a 10 percent maximum. Within all of these categories, there are multiple combinations of interest rate and origination fees.

The specific HECM that works best depends on the senior’s financial needs and preferences.

Reserve for Contingencies

Seniors who want a reserve for contingencies will be offered credit lines on adjustable rate HECMs only — there are no fixed-rate lines. They may select the adjustable that provides the largest initial credit line, or the one that provides the largest line at some future time, depending on their expectations regarding when they will begin drawing on the line.

The senior who focuses on the largest initial line could find it on either an annual or a monthly adjustable. If they focus on the largest line at some future time, they will select the annual adjustable, unless they are convinced that rates will rise by more than 5 percent above existing levels, in which case they might select the monthly adjustable.

Note that seniors selecting among alternative credit lines can ignore the interest rate and origination fee, which are important to them only because they affect credit lines. This is also the case for the other financial needs discussed below.

Permanent Increase in Monthly Payment

Some seniors want more income “permanently,” meaning for as long as they occupy their homes. The logical choice would be the adjustable-rate HECM that provides the largest such payment.

However, seniors concerned with how much home equity they will leave to their estate might select the HECM that minimizes future debt.

Cash Draw

Some seniors need cash for any of the plethora of reasons. Home purchase is excluded, however, because it is considered as a separate category below.

Seniors can obtain cash at closing with either a fixed-rate or an adjustable-rate HECM. While the amounts available are very similar, the cash draw at closing ends the process for the fixed-rate option. No additional funds can ever be drawn.

With the adjustable, in contrast, a second cash draw is available after 12 months roughly equal to about two-thirds of the draw at closing. A senior looking for the maximum cash over 12 months will take the adjustable offering the largest total. A senior with more modest needs with a concern about the size of her estate might prefer the fixed-rate version that results in the greatest equity after some period.

Combination Monthly Payment and Credit Line

Some seniors want both a monthly payment and a credit line.

They will specify their desired payment, which could be for their entire tenure in the house or for a shorter period, and use the remainder of their borrowing power to draw a credit line. They will select the adjustable-rate HECM that provides either the largest initial line or the largest line after some period — the same decision process as when they select a credit line only.

Purchase a House
Most seniors who purchase a house with a HECM want to minimize the asset liquidation needed for the purchase, so they want the HECM that will provide the largest amount of cash up front.

This could be a fixed-rate or an adjustable rate, but with interest rates moving up, it is more likely to be an adjustable.

In both cases, the senior pays a 2.5 percent insurance premium for the privilege of using all HECM borrowing power at the outset.

The senior willing to draw less than 60 percent of the maximum on an adjustable will pay only a 0.5 percent premium and will obtain a significant credit line that becomes useable after 12 months.