How to Finance Home Purchase With Reverse Mortgage

Mortgage News

Mortgage Daily Staff

                                                 April 27, 2017

One of the biggest upsides to purchasing a house with a home-equity conversion mortgage is that doing so does not impose a monthly payment burden on the borrower.

The disadvantage is that this type of reverse mortgage, offered through the Federal Housing Administration, will cover only about 50-60 percent of the house price, depending on the borrower’s age. That means the purchaser will need to find the remaining required 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 to draw the largest amount of cash possible and pay the highest mortgage insurance premium, or draw 60 percent of the maximum and pay a lower premium.

Second, they have to select the lender offering the best terms.

Selecting the Cash Draw/MIP
Most house purchasers select the reverse mortgage that maximizes the cash draw at closing, minimizing the amount they must raise from asset liquidation.

However, this is not necessarily the most advantageous way to go because the Department of Housing and Urban Development penalizes borrowers who draw the maximum amount of cash at closing. They must pay an up-front mortgage insurance premium, or MIP, of 2.5 percent of the property value, compared to an MIP of 0.5 percent when cash draws are no more than 60 percent of the maximum.

The borrower who limits the up-front cash draw to 60 percent of the maximum receives a credit line for the remaining 40 percent, which can be exercised after 12 months. The benefit is that the loan balance in the future will be lower because of the lower MIP. This could be important to seniors who are concerned with the amount of home equity they leave in their estate.

The downside is that the borrower will have to come up with more cash at closing by liquidating more assets or by borrowing for a year. The credit line provides an assured source of funds for repaying any such loan.

In the table below, I illustrate this choice with a hypothetical unmarried senior of 72 purchasing a $400,000 house financed by lender A. If the purchaser selects the high MIP, she can borrow $86,610 more at closing.

With the low MIP, she gets a credit line of $94,560 after 12 months. If she takes the low MIP and draws the full line, she will also owe less after 10 years, although the difference is not great. But before making a decision on which way to go, the purchaser should look at what other lenders offer.

Selecting the Lender

The reverse mortgage market is extremely inefficient because very few borrowers try to shop. As a result, the prices of identical transactions can differ materially. This turned out to be very much the case when I shopped the lenders on my site for a reverse mortgage that would finance a house purchase.

Five lenders quoted prices for both low-MIP and high-MIP transactions. Lenders A and D, as seen below, quoted the same price for both. Lenders B and C quoted a higher price for the low-MIP case. And lender E quoted a higher price for the high MIP case. I was not surprised that lenders would price the low-MIP case higher because these transactions have smaller initial loan amounts on which originators earn a premium. They are therefore less profitable. I was not surprised that lenders would price the MIP options the same because they might not want to discourage the low-MIP option. But pricing the more profitable high-MIP case higher makes no sense at all.

Price differences between the lenders are shockingly large. On a high MIP loan, lender D charges a rate of 4.427 percent while lender C charged 3.552 percent, a difference of 0.875 percent. Bear in mind that these lenders know that they will be shopped. If I had price data for lenders who advertise on TV, I am sure the price spreads would be even wider.

Bottom Line

The house purchaser with access to the data in the table would select lender C if she wanted the maximum cash draw at closing, and either C or E if she wanted the low MIP. Purchasers who attach themselves to one lender without knowing how that lender’s pricing compares to others take an enormous gamble. That is the rationale for my multi-lender network.

Borrower age 72, house purchase of $400,000 in ZIP 90003. Selected prices of adjustable-rate reverse mortgages quoted by five lenders on April 5, 2017:

Lender A high MIP
Interest rate and origination fee: 4.177 percent, $2,499
Cash from mortgage: $222,331
Credit line in 12 months: 0
Loan balance after 10 years: $406,263

Lender A low MIP
Interest rate and origination fee: 4.177 percent, $2,499
Cash from mortgage: $135,721
Credit line in 12 months: $94,560
Loan balance after 10 years: $397,698

Lender B high MIP
Interest rate and origination fee: 4.302 percent, 0
Cash from mortgage: $224,780
Credit line in 12 months: 0
Loan balance after 10 years: $411,350

Lender B low MIP
Interest rate and origination fee: 4.302 percent, $2,250
Cash from mortgage: $135,970
Credit line in 12 months: $94,560
Loan balance after 10 years: $402,483

Lender C high MIP
Interest rate and origination fee: 3.552 percent, 0
Cash from mortgage: $224,780
Credit line in 12 months: 0
Loan balance after 10 years: $381,750

Lender C low MIP:
Interest rate and origination fee: 3.552 percent, $2,500
Cash from mortgage: $135,720
Credit line in 12 months: $94,560
Loan balance after 10 years: $374,605

Lender D high MIP
Interest rate and origination fee: 4.427 percent, 0
Cash from mortgage: $224,780
Credit line in 12 months: 0
Loan balance after 10 years: $416,500

Lender D low MIP
Interest rate and origination fee: 4.427 percent, 0
Cash from mortgage: $138,220
Credit line in 12 months: $94,560
Loan balance after 10 years: $407,327

Lender E high MIP
Interest rate and origination fee: 4.25 percent, 0
Cash from mortgage: $224,780
Credit line in 12 months: 0
Loan balance after 10 years: $409,226

Lender E low MIP
Interest rate and origination fee: 3.802 percent, 0
Cash from mortgage: $138,220
Credit line in 12 months: $94,560
Loan balance after 10 years: $383,678

Note: The loan balances in the low mortgage insurance premium category assume the credit line is fully used in month 13. All adjustable-rate reverse mortgages have a maximum rate increase of 5 percent, but future balances are calculated using the initial quoted rate.

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

Mortgage Daily Staff

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