The more I work with home-equity conversion mortgages -- reverse mortgages offered through the Federal Housing Administration -- the more convinced I become that the HECM is the most underutilized financial tool available to consumers in the U.S.
Among the important reasons for underutilization is that HECMs are more complicated than any other financial instrument offered to consumers. They are complicated in order to meet a wide diversity of senior needs.
But this poses the challenge of matching the individual senior's need to the appropriate HECM option or options.
Many, if not most, seniors are not up to that challenge on their own, and the available decision support is poor.
- The Department of Housing and Urban Development offers virtually none.
- Lenders focus on doing deals. Whether the option selected is the one that best meets the senior's long-term needs is incidental.
- HECM counselors do not offer advice on which HECM options would best serve the client.
- Many retirement planners do not even consider HECMs, and few of those who do have the expertise to advise seniors about which option or options would work best.
I have tried to fill this gap by writing articles on HECM uses and collecting current HECM price data from a group of lenders.
Ideally, a calculator should have a separate branch for each category of senior needs. I am going to illustrate this with one well-defined category of senior homeowners, one of whom is Jamie R.
Jamie is 62 and belongs to a rapidly growing category of consumers approaching retirement who have no pension other than social security, have paltry savings, but do have significant equity in a home.
Because he also has a long remaining life ahead of him, Jamie plans to continue working until he reaches 70. At that point, his income will plummet and Jamie will want to replenish it, at least in part, by drawing funds from a reverse mortgage.
How exactly would he do that?
The best way involves using two HECM options.
One option is a credit line, which is the right to draw cash for any purpose in an amount up to the total amount of the line. That amount rises over time so long as it is not used.
The second option is a monthly payment, which can be for a specified number of years, or it could last as long as the borrower resides in the home -- called a "tenure payment." A credit line can be used at any time to purchase a monthly payment.
Jamie's best strategy is to take a HECM credit line at 62 and let it sit unused until he stops working and wants income replenishment to kick in. At that point, he would convert the credit line into a tenure payment.
During the intervening period, the unused line will grow at a rate equal to the interest rate on his reverse mortgage plus the mortgage insurance premium of 1.25 percent.
Here is an illustration: I assumed that Jamie's home was worth $400,000 and that he will want to replenish his income in eight years on reaching age 70.
As of May 18 tenure payments were as follows: $1,555, $1,557, $1,640, $1,722, $1,724, $1,748, $,1979.
The range of $424 between the highest and lowest is a reflection of how imperfect the HECM market is.
Would Jamie do just as well if he waited eight years and took out the HECM then?
If Jamie waited eight years before taking the HECM, and if his house appreciated 4 percent a year during the eight years, the tenure payment available at that point from the lender offering the best deal would be $1,887 instead of $1,979. The difference is that the unused credit line grew at 5.77 percent during the eight years rather than the 4 percent that I assumed for property appreciation.
Obviously there are scenarios in which home prices rise faster than interest rates, but they are unusual and unpredictable. In most cases, it will not pay to wait.
The bottom line in Jamie's case is the set of tenure payments in year eight.
About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.