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Best Reverse Mortgage Option for Limited Period

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“I am interested in your opinion of the following plan: Take a HECM reverse mortgage on my home, which is worth $1,000,000 and will appreciate by 3.5 percent a year. I would draw on the HECM for cash to invest or monthly income, then sell the house after 12 years, repaying the HECM from the house appreciation.”

Your letter points up the potential use of HECM reverse mortgages for a limited period, though with multiple possible purposes. You don’t say how old you are so I am going to assume you are 62, the minimum age to qualify for a HECM. If you are older, the draw amounts I refer to below will be understated.

You should also be aware that the amounts you can draw on a HECM are no greater with a house worth $1 million than with one worth $679, 650. This is the FHA maximum claim amount, which caps how much you can draw. It is adjusted every year.

I used an HECM calculator to assess three options: drawing cash to invest, drawing a monthly payment for 12 years, and drawing a monthly payment for as long as you reside in the house (a “tenure payment”).

In each case, I chose the HECM that provided the largest draw amounts, which for the first two options turned out to be an ARM with an initial rate of 3.350 percent and an origination fee of $6,000. For the third option, the HECM providing the largest draw had an initial rate of 4.525 percent with a zero origination fee.

These were the best prices quoted by any of the seven lenders who deliver their HECM prices.

Option 1
Viewing the HECM as a way to increase investment income, you would draw the maximum cash allowed at closing ($177,000) and the maximum after 12 months ($137,583). To make this pay over your 12-year horizon, these draws would have to grow to exceed the $517,055 balance on your HECM after 12 years.

While the interest rate you would pay on the HECM is only 3.350 percent, your initial loan balance to which the rate applies includes an origination fee of $6,000, mortgage insurance premium of $13,593, and other closing costs estimated at $2,000. The break-even rate of return on your investments is 4.3 percent, so you would have to earn more than that to come out ahead.

Furthermore, your HECM is adjustable rate. If market rates increase, the initial rate of 3.350 percent could rise as high as 8.350 percent, which would make the future loan balance higher than the $517,055 figure cited above, raising the rate you would need to earn on your investments to cover it. I don’t recommend using a HECM to fund investments.

Option 2

Viewing the HECM as a method of supplementing your spendable funds, you could draw a monthly payment of $2,722 for 12 years. At that point, your payment would stop and you would owe $533,081 on your HECM.

At 3.5 percent, your house appreciation over the 12 years would amount to $511, 069, so your net worth would be almost the same. Since your monthly draws will total about $392,000, this option has some appeal.

Option 3

As an alternative method of supplementing your spendable funds, you could draw a monthly tenure payment of $1,364. While this payment is only half as large, it would generate a debt of only $298,485, assuming no change in interest rates. This would be considerably less than the appreciation expected on your home.

An advantage of the tenure payment is that it continues until you die or move permanently from your house, which means that you have an opportunity to change your mind about terminating the HECM after 12 years. If interest rates escalate, paying off the HECM will be more burdensome, but the monthly payment will not change. Monthly payment draws are not affected by a rise in HECM interest rates that occurs after a HECM is originated.

The example discussed above illustrates a strategy for using HECMs to convert appreciation in house value into spendable funds for a specified period. The strategy should be particularly attractive to seniors with high-value houses. While they cannot draw more funds than someone with a house value equal to the FHA maximum claim amount, the value growth of their homes is larger, providing greater capacity for repaying the HECM loan balance.

About the Writer

Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.

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