When I wrote about purchasing a house with a home-equity conversion mortgage earlier this year, a major issue faced by borrowers was whether to pay a penalty insurance premium in order to maximize the cash draw on the reverse mortgage.
A few months after the article was written, the Department of Housing and Urban Development eliminated the option of paying a lower premium if the borrower drew less cash. The upfront mortgage insurance premium is now 2 percent of property value regardless of how much the borrower draws.
The advantage of buying a house with an HECM has not changed. It remains the case that the HECM does not impose a monthly payment burden on the borrower. The only disadvantage is that the reverse mortgage will cover only about 50-60 percent of the house price, depending on the borrower’s age, requiring the purchaser to find the remaining needed cash elsewhere. The most common source is asset liquidation.
Seniors who go this route have two decisions to make. First, they must decide whether they want an adjustable rate or a fixed-rate HECM. Second, they have to select the lender offering the best terms. I will illustrate these decisions with the case of Charles, who is 72 and wants to purchase a $400,000 house on Dec. 18, 2017.
Fixed Rate or Adjustable Rate?
Most seniors will select the option that provides the larger cash draw. Among five lenders quoting a price to Charles, the largest cash draw on an adjustable rate was $201,800, whereas the largest draw on a fixed-rate was $194,600. The adjustable provided $7,200 more, which could settle the matter.
Or perhaps not.
If Charles is concerned with the size of his estate, he will also look at how large his future loan balance would be. Looking ahead 10 years, for example, the balance of the adjustable will be $389,356 compared to a balance on the fixed of $406,386. He will owe $17,030 less on the adjustable.
This is not quite the slam-dunk it may appear, however. The future loan balances are calculated at the interest rates on Dec. 18, which were 3.21 percent on the adjustable rate and 3.99 percent on the fixed rate. While the rate on the fixed will remain at 3.99 percent over its life, the rate on the adjustable rate could rise as high as 8.21 percent if market rates increase. Were that to happen in the near future, the balance on the adjustable rate would quickly come to exceed the balance on the fixed. It is unlikely that the risk of future rate increases will dissuade Charles from selecting the adjustable rate, but it could.
Selecting the Lender
The reverse mortgage market is extremely inefficient. Few seniors try to shop. As a result, the prices of identical transactions can differ materially from one lender to another.
When participating lenders know that their price quotes will be compared to others, price differences are large. For example, on the day my hypothetical house purchaser was quoted an adjustable rate of 3.21 percent with a cash draw of $201,800, another lender quoted a rate of 4.76 percent and a cash draw of $172,005, or $29,795 less. That was the worst quote among five lenders who lend in California. The quotes of the other three lenders were in-between the best and the worst.
Bottom Line
Seniors who want to purchase a house with a HECM and who have no concern regarding the amount of home equity they leave to their heirs can easily shop lenders for the largest cash draw. They can shop multiple lenders online or by contacting individual lenders one lender at a time. If they shop by contacting individual lenders, the process should be completed within a week ending on a Monday because HECM lenders reset their prices on Tuesday.
Purchasers who do have a concern for what their heirs will inherit will want to see not only cash draws but also projections of future loan balances that are consistent from one lender to another.
