Many senior homeowners are attracted to the idea of using a reverse mortgage to draw additional funds but are so fearful of making a costly mistake involving their house, or being taken advantage of by loan providers, that they are immobilized and do nothing.
The three-step strategy described below is directed to them. It is risk-free because all three steps can be done without contacting a lender.
A home-equity conversion mortgage, or HECM, is a reverse mortgage offered through the federal government.
The Three-Step Strategy
- Identify your financial needs that might be met by a HECM.
- Determine whether the amounts you can draw with a HECM, immediately or in the future, justify the decline in your home equity.
- Narrow the selection by comparing price quotes from different lenders, and different combinations of interest rate and origination fee.
If you take the three steps and decide a HECM is not for you, that is the end of it — no loan providers will call.
If you decide to proceed, you can contact a lender with the confidence that comes from knowing exactly what your options are, and which options you want.
Step 1: Defining Your Financial Needs
In counseling seniors about HECM reverse mortgages, I have found that they fall into five groups that have different financial needs.
Each of these groups requires different information to make good decisions.
This information includes financial projections of future HECM debt, unused credit lines and other factors over periods that are relevant to each individual borrower.
The different financial needs are as follows:
- Draw the largest possible initial or future credit line, with or without a cash draw.
- Draw the maximum possible monthly payment for as long as you live in the house.
- Draw as much cash as possible, at closing or after 12 months.
- Draw a smaller monthly payment plus the largest possible credit line.
- Purchase a house with the smallest possible cash outlay.
Steps 2 and 3 for a Borrower Looking for the Largest Credit Line
I am going to illustrate steps 2 and 3 for a 65-year old named Smith who has a house worth $400,000, who wants the largest possible credit line and is looking ahead 10 years.
The credit lines calculated at step 2 are based on prices from the lender whose HECM generated the lowest debt after 10 years.
With this HECM, Smith could have obtained an initial credit line of $210,000, which if unused, would grow to $330,000 in 10 years at current interest rates, and to $496,000 at the maximum rate on the HECM.
The cost, measured by how much Smith would owe after 10 years in the absence of any draws, is $11,000 at current rates, $17,000 at the maximum rate.
Assuming that Smith considers this a good deal, he should proceed to step 3 and see if there isn’t another deal he prefers.
One lender offers a line that grows to $378,000 at current rates but the cost of $18,000 at current rates would also be greater.
Whether this is a better deal only Smith can decide.
Steps 2 and 3 for a Borrower Looking for the Largest Monthly Payment
Jones is the same age as Smith and her property value is the same, but Jones wants to use her borrowing power to draw the largest possible monthly stipend starting immediately, and lasting as long as she lives in her house.
This is called a “monthly tenure payment.” Jones wants to measure the cost of a HECM over 15 years rather than 10.
On Sept. 3, the monthly payment on an HECM that would have resulted in the lowest debt after 15 years was $939. At current rates, she would owe $253,000.
Assuming that Jones considers this a good deal, she should proceed to step 3 and see if there isn’t another deal that would be more advantageous.
Among the possibilities is a tenure payment of $1,161 that would generate a debt of $364,000 over 15 years. It is for Jones to decide whether an additional $222 a month was worth an additional $111,000 of future debt.
Bottom Line
I am not covering the remaining three categories of financial need because I don’t have the space, besides which it would be heavily repetitious.
The important points are, first, that no matter what financial need category a senior falls into, a decision to take a HECM reverse mortgage or not should be data-based and include information about what is likely to happen in the future.
Second, seniors who elect to go ahead with a HECM have options, and the more lenders from whom they obtain price quotes, the more options they have.
But again, to select wisely from among their options, borrowers need information about what is likely to happen in the future.
About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.
