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Guiding borrowers to the right decisions Protecting borrowers from mortgage predators |
Do you own a house, are you
62 or older, and are you worried about running out of money
down the road? If your answer is “yes” to all three
questions, you should take out a HECM reverse mortgage ASAP.
Some
financial planners advise seniors to delay taking out a
reverse mortgage if they don’t need the money now. Their
argument is that by waiting the amount they will be able to
draw increases, reflecting their shorter remaining life span
and appreciation in the value of their property.
This advice is plausible for seniors who would be tempted to use up most of their borrowing power shortly after they took out the HECM, but it is poor advice for those prepared to wait it out. This article explains why.
The
Federal HECM reverse mortgage program allows seniors of 62
or older who own and occupy their homes to take out a
mortgage against it. What makes it a “reverse mortgage” is
that the amount owed tends to rise over time, whereas on a
standard mortgage it tends to decline.
This
difference arises from another one, which is that no payment
is required on a HECM until the senior sells the house,
moves out of it permanently, or dies. On standard mortgages,
as every borrower knows all too well, they must begin making
payments immediately.
Another important
difference between HECMs and standard mortgages is the role
of interest rates. A feature unique to HECMs is that every
transaction involves two interest rates.
Expected interest Rates
The
expected rate on a HECM is used to calculate the amount the
senior can draw under the different options. Seniors can
draw cash, take a credit line, or receive monthly payments
for life or for a specified term. The higher is the expected
rate, the smaller is the amount obtainable under any of
these options. Part of the reason it does not pay to delay
taking out a HECM is that expected rates are very likely to
rise in future years, which will reduce the size of future
HECM draws.
The
accrual rate on a HECM is the rate used to calculate the
interest due the investor every month, exactly the same as
on a standard mortgage. The only difference is that on a
standard mortgage the borrower must pay the interest due
every month whereas on a HECM the interest is added to the
loan balance.
The
accrual rate on a HECM can be fixed or adjustable, but the
fixed rate is available only on transactions in which the
borrower draws the maximum amount allowable in cash.
Borrowers who want a credit line or a monthly payment plan
must accept an adjustable rate.
Some
seniors have been frightened away from adjustable rate HECMs
because they have heard horror stories about borrowers who
were bludgeoned by rising rates. But rising rates endanger
borrowers only when they result in rising required payments,
as they do on standard adjustable rate mortgages. There is
no required payment on HECMS.
Furthermore, rising rates on HECMs benefit borrowers with unused credit lines, which grow at the same rate as debt. This is a second part of the reason it does not pay to delay taking out a HECM. While rising expected interest rates in the future reduce the size of the draws available to those who wait to take a HECM, rising accrual rates increase the growth rate of the credit lines that are taken out now.
I have done extensive modeling to compare unused credit lines, debt and equity on a standard adjustable rate HECM in 10 years if a) the borrower takes one now at age 62 and does not draw any funds during the 10 years, or b) waits until she is 72 to take the HECM. See the table at the bottom.
If this
comparison is done on the assumption that current interest
rates continue for 10 years, then it pays to wait. For
example, if the borrower has a property worth $200,000
today, her maximum credit line is $115,059 which if unused
will grow to $162,430 in 10 years at current interest rates.
If she waits 10 years to take out the HECM, her line will be
$189,283 because she will be 10 years older and her property
will be worth more.
However,
if the accrual rate plus mortgage insurance premium average
8% over the 10 years rather than the 3.453% rate today, the
unused line will grow to $255,390, or well in excess of the
$189,283 line she could draw by waiting. And if the expected
rate in 2023 is 10% instead of 4.12%, the line available by
waiting until 2023 to take the HECM would be only $82,410.
Of
course, we can’t predict the future with any degree of
certainty, but in my view, the odds strongly favor taking
the HECM now. This partly reflects a judgment that interest
rates are bound to rise over the next 10 years. Further, the
magnitudes involved are also compelling. On a stable rate
assumption the benefit of waiting is $26,853 while on the
rising rate assumption, the benefit of taking the HECM now
is $172,980.
There is
one important proviso to the argument that it pays to take
out a HECM as soon as possible. The argument applies only to
those who leave their credit line largely unused. If you
draw more than half of it out right away, rising rates will
expand your debt faster than it will expand your unused
credit line. Compulsive spenders might well do better by
waiting.
HECM on House Worth $200,000 in 2013:
Status in 2023 if HECM Is Taken Now Versus 2023
|
|
2013 |
Status in 2023 |
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|
Credit Line at 4.12% Expected
Rate |
Initial Amount Owed |
Unused Credit Line |
Amount Owed |
Property Value at 4% Growth
Rate |
Equity |
|
|
Take HECM Now, Stable Rates |
$115,059 |
$8,741 |
$162.430 at 3.453%* |
$12,340 at 3.453%* |
$296,049 |
$283,709 |
|
Take HECM Now, Rising Rates |
$115,059 |
$8,741 |
$255,390 at 8%** |
$19,402 at 8%** |
$296,049 |
$276,647 |
|
Take HECM in 2023, Stable Rates |
|
|
$189,283 at 4.12% |
$11,142 |
$296,049 |
$284,907 |
|
Take HECM in 2023, Rising Rates |
|
|
$82,410 at 10%*** |
$11,142 |
$296,049 |
$284,907 |
**Assumed average ARM accrual rate plus
1.25% mortgage insurance premium over 10 years
***Assumed expected rate in 10 years