Jane took out a home-equity conversion mortgage on her house five years ago when she became 62. An HECM is a reverse mortgage.
Because she was still employed at the time, she elected to take a credit line, which she has used sparingly ever since.
She has now quit her job and wants to receive the largest possible payment every month — a “tenure” payment, which is paid for as long as she remains in her home.
Jane has options.
She can modify her HECM by converting her unused credit line into a tenure payment.
But she can also refinance, taking the largest possible tenure payment on a new HECM. Jane wants to know which of these payments would be larger. She may also want to know which option will cost her estate the most.
Refinancing and Modification as Options
Refinancing and modification are alternative ways of changing the features of a mortgage. With a refinance, the changes occur by terminating the old contract and executing a new one. With a modification, borrower-initiated changes occur within the existing contract between borrower and lender. That contract must include provisions that make modification possible.
Both forward and reverse mortgages allow borrowers to refinance without a penalty, and in both cases borrowers can modify the loan by paying down the balance. However, HECM reverse mortgages allow several other types of modification that are not available on forward mortgages.
Types of HECM Modifications
One type allows borrowers with an unused credit line to draw on it, either on a discretionary month-to-month basis or by taking a fixed monthly payment over some specified period. Another HECM modification allows borrowers who are drawing a monthly payment now to increase it if the existing draw is less than the maximum, reduce it, change the period over which it is drawn or convert it (in whole or in part) to an unused credit line.
These options to modify a HECM mean that in some cases modification and refinancing are competing ways to draw funds. This is the case with Jane.
Factors Affecting the Decision
Working in favor of the refinance option is that Jane is now five years older and the value of her house has increased, both of which command larger monthly payments.
Working against the refinance option is that it involves a new set of closing costs, which reduces payments. A modification costs only $20. But knowing all this doesn’t answer the question of which option will provide the largest payment.
About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.