October 4, 2004, Revised October 25, 2006, November 16, 2007, December
2, 2008, January 27, 2010, July 27, 2012, January 15, 2013
"My wife and I are 68 years old and can qualify for a reverse mortgage
on our current house, but we want to relocate first. Can we buy a new
house with a "forward" mortgage, and then take out a reverse mortgage?"
There are three ways to acquire a new house while taking out a reverse
mortgage. One way is to buy the new house with a mortgage small enough
that it can be paid off with the proceeds of the reverse mortgage. The
second way is to pay all-cash for the house, then reverse mortgage it as
before. The third way is to purchase the house and take out the reverse
mortgage in one transaction. These will be considered in turn.
Buy With a Mortgage, Repay With a Reverse Mortgage
If you take out a forward mortgage to purchase a house, you must repay
it when you take out a reverse mortgage. You do that by drawing a lump
sum under your reverse mortgage equal to the balance of the forward
mortgage. The balance must be smaller than the maximum amount you can
draw under a reverse mortgage.
For example, suppose you pay $200,000 for your new house. A married
couple both of whom are 68, on December 2, 2008, could draw a lump sum
under a Home Equity Conversion Mortgage (HECM, which is the FHA reverse
mortgage), secured by that house, of about $120,000. If you took out a
forward mortgage of $160,000 to buy the house, you would not be able to
pay it off with the HECM and therefore would be ineligible. If you took
out a forward mortgage of $100,000, you would be able to pay it off by
drawing on the HECM, but there would be only about $20,000 left for
other purposes.
That doesn't mean you shouldn't do it. Eliminating the forward mortgage
eliminates the monthly payment on that mortgage, which frees up your
income for other purposes. Further, the unused part of the line ($20,000
in my example) will grow every year year, depending on future interest
rates, so you will have more to draw on in the future if you don't use
it up now.
You can draw only $120,000 on a $200,000 house because at 68 you are
still expected to live a long time and the reverse mortgage lender is
going to have to wait a long time before he gets his money back. If you
were both 76, you could draw almost $140,000, and would only need to put
30% down. And if you were both 86, you could draw almost $160,000 and
would only need to put 20% down.
Features You Want in the Forward Mortgage
If you purchase the home with a forward mortgage, you want one that
costs as little as possible over the short period you will have it. It
matters little whether the interest rate is adjustable or fixed, or
whether the term is 15-years or 30. What matters most is the upfront
mortgage costs, which you want to minimize.
Upfront costs consist of points, which are a lender charge expressed as
a percent of the loan; lender fees expressed in dollars covering
different services, but only the total amount matters; and mortgage
broker fees, which can be expressed in percent, in dollars or both. The
trick to avoiding all these costs is to pay an interest rate high enough
that the lender will pay you points, called a "rebate." The best
instrument for this purpose is a 30-year fixed-rate mortgage (FRM)
because they carry the largest rebates.
For example, a lender offering a 30-year FRM at 6% and zero points might
quote 2.75 points at 5.5%, and rebates of 2.125 points at 6.5% or 3
points at 6.75%. You want a rebate large enough to cover the other
lender fees plus the mortgage broker’s fee. If the rebate is larger than
needed for that purpose, however, it won’t go to waste; the excess can
be applied to third party charges, such as title insurance.
Also, you must make absolutely sure that your loan does not carry a
prepayment penalty. Pay careful attention to the Truth in Lending
disclosure statement that you receive. Near the bottom, it will say that
if you pay off your loan early, you either may, or will not, have to pay
a penalty. If it is marked may, it means you will have to pay a penalty.
See
Disclosure Rules on Prepayment Penalties. Note that the revised Good
Faith Estimate that became effective January 1, 2010 shows whether or
not you have a prepayment penalty on page 1. See
The New GFE Will Help Borrowers.
Note: Lenders do not like making loans carrying large rebates that are
paid off very quickly, and if such a loan comes through a mortgage
broker, they may well require the broker to pay back the rebate. It
would be best, therefore, to obtain such a loan from a lender rather
than a broker.
Buy With All-Cash, Then Do a Reverse Mortgage
You can avoid all costs on a forward mortgage by not taking one -- by
paying all cash for your new house. Since you must put 50% down anyway,
you should consider putting 100% down. If you have the cash sitting in
low-yield investments, that would be a prudent move. You would then have
access to your entire HECM credit line, which could be drawn on to
replace some of the assets you liquidated to purchase the house, or for
any other purpose. You
can learn about the various
HECM options for drawing funds, and see how much you can draw under each
option from lenders certified by the professor, by clicking
HERE.
Buy the House With a Reverse Mortgage
In 2008, Congress authorized a "HECM for Purchase" program, under which
seniors can buy a house and take out a fixed-rate reverse mortgage at
the same time, incurring only one set of settlement costs. This is now
the simplest and best way to buy a house with a reverse mortgage. It is
discussed more fully in
Buying a House With a HECM Reverse Mortgage.
