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Guiding borrowers to the right decisions Protecting borrowers from mortgage predators |
Part of the motivation to be a homeowner is the opportunity
to accumulate growing equity in a home. Equity growth,
however, is heavily influenced by market changes over which
the owner has little control. House prices appreciate much
more in some areas than in others, and there are some areas
in which there is no appreciation at all.
A homeowner reaching 62 can begin converting home equity
into spendable funds by taking out a HECM reverse mortgage.
In calculating the amounts that a senior can draw using a
HECM, the Government assumes the borrower’s house will
appreciate by 4% a year. This was the average rate for all
areas over a period of many decades.
The individual taking out a HECM reverse mortgage today
could experience 4% appreciation, but more likely the rate
will be higher or lower. The way the program is designed,
the borrower is protected against the adverse consequences
of a rate below 4%, and allowed to enjoy the benefit of a
rate above 4%. The HECM program allows the owner to hedge
her property value risk. Here is an example.
Jane Doe is 65, has a house worth $200,000, and wants to
draw the maximum amount possible every month for as long as
she lives in the house – called a “tenure payment”. As of
November 17, the largest amount available from any of the 5
lenders who deliver their prices to my web site turns out to
be $566 a month.
Now lets consider the implications
of two extreme assumptions about the future value of Jane’s
property. In assumption 1, appreciation is zero, meaning the
property value remains at $200,000. Jane’s HECM debt,
however, rises every month. Assuming the initial interest
rate on her reverse mortgage continues, the debt passes
$200,000 in the 18th
year, and if she lives to 90, she will owe about $335,000.
Since there are no deficiency judgments against Jane or her
estate, the loss is taken as a charge against the
Government’s reserve account. That account is fed by
insurance premiums paid byJane and all other HECM borrowers
to cover this and other risks.
In sum, Jane continues to receive the payment calculated on
a 4% appreciation assumption, even though her house has not
appreciated at all.
Now consider the implications of an alternative assumption,
where Jane’s house appreciates at a rate of 8%. That means
that after, say, 10 years, her house will be worth about
$432,000, at which point she will owe about $96,000 on her
HECM. Her equity at this point is the difference of
$336,000, which is more than when she took out her HECM, and
she is now10 years older with a shorter life expectancy.
If she refinances after 10 years, which means paying off the
balance on the first HECM, her new monthly payment is $1024,
or almost twice as much as the payment on her first HECM.
The refinance option allows Jane to profit from the
atypically high appreciation rate on her home.
The HECM program provides another benefit to borrowers
looking to refinance – the upfront mortgage insurance
premium is applied only to the value increase over the
original value. In Jane’s case, the premium would be applied
to $232,000 rather than $432,000.
The high appreciation rate case raises some interesting
questions. A micro question that could become a major focus
of retirement advisors down the road is: when is the best
time to refinance a HECM? The longer the borrower waits, the
higher the new payment will be relative to the initial one
but the shorter the period she will have it.
The macro question that arises is whether the losses to FHA
associated with this borrower-friendly feature of the HECM
program have been fully taken account of in the agency’s
mortgage insurance charges. Interest in this question is
heightened by the recently announced results of the annual
assessment of FHA’s HECM reserve account, which showed a
rising deficit. Stay tuned on this.