Most seniors in the market for a home-equity conversion mortgage who are still carrying a mortgage balance view the HECM — the Federal Housing Administration’s reverse mortgage program — as their way of ridding themselves of a monthly payment. If there is an existing mortgage balance, enough cash must be drawn from the HECM to pay it off.
However, some senior homeowners have enough financial assets to pay off the balance before they take the HECM, if it makes financial sense to do that.
It turns out that whether or not it makes sense may depend on where the homeowner goes to get the HECM.
I look at the question through the eyes of a 62-year old with a house worth $400,000 that has an existing mortgage balance of $100,000. I assume that the owner wants the reverse mortgage that provides the largest possible monthly payment for as long as she lives in the house — what’s called a “tenure payment.”
If she pays off the $100,000 balance before taking the HECM, she’d get a monthly payment ranging from $970 to $1,143, based on quotes given on May 27 by six lenders. If she does not pay off the $100,000 balance beforehand, the available payments from the same lenders range from $453 to $618. The payments are lower in this case because the HECM is using part of the senior’s borrowing power to pay off the existing balance.
Using the highest of the monthly payment quotes, the difference between the two cases ($1143 minus $618) is $525. Paying off the $100,000 balance before taking the HECM increased the tenure payment by $525, but the borrower would lose the income she was earning on the $100,000.
To match the $525 increase in the monthly payment, the $100,000 would have to yield 6.3 percent after-tax and risk-free, which is possible but not very likely. While this leaves the $100,000 capital value intact, that is largely offset by the lower future HECM loan balance of the borrower who pays off the balance beforehand. After eight years, she will owe $86,000 less.
A cleaner comparison assumes that in the case where the $100,000 mortgage balance is paid off by the HECM, the borrower would use the $100,000 of financial assets to buy an annuity.
On May 27, I priced an immediate life annuity on $100,000 for a 62-year-old man at $498, which is not that different from the $525 difference in tenure payment, considering that a life annuity can go on a little longer than a tenure payment. From a cash flow perspective, it is about a draw. That leaves the lower HECM loan balance of the borrower who pays off the balance beforehand as a net benefit of that option. That may or may not be important to the borrower, depending on her attitude toward bequests to her survivors.
There is one other potential benefit to paying off a loan balance before taking a HECM. The range of payments quoted by lenders is twice as large when the HECM pays off the balance than when the borrower pays it beforehand. The sum of $618 is a whopping 36 percent higher than $453, while $1,143 is only 18 percent higher than $970. The larger spread in the first case reflects the greater profitability of a HECM with a large initial loan balance, which provides greater pricing latitude and results in a wider range of price quotes.
The wider range of price quotes doesn’t matter if the borrower can shop effectively for the highest payment. To see whether it was possible to shop individual lenders online, I checked the websites of 15 HECM lenders, including the five largest. Only one of them, All Reverse, displayed tenure payments and future debt. I stopped my inquiry at 15, but if any of the lenders I missed provide this information on their websites, they can let me know and, if it checks out, I will add their names to the web version of this article.
Borrowers who get locked into one lender are rolling the dice and will do better paying off the balance before taking the HECM.
About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.
