REVERSE MORTGAGE INFORMATION: Tools, News and Resources to Help Seniors Decide

In a previous post we noted an important fact largely ignored in the plethora of recent books and articles on reverse mortgages: the majority of reverse mortgages (at least HECM reverse mortgages) terminate within seven years of their origination. For many of these borrowers, a standard home equity line of credit loan (HELOC) might have been a more efficient borrowing tool.

Of course no one can predict the future and we suspect many HECM borrowers entered into their loans with thoughts of staying put for ten years or more. But, as noted, data from actual HECM loans reveals that fewer than 50% of HECMs last beyond seven years. For shorter periods such as these, the HELOC option is certainly worth investigating.

How does someone decide which is better for them – HECM reverse mortgage or HELOC? Let’s start by reviewing the the main points that differentiate the two types of home equity borrowing: (more…)

HECM loans and HELOCs (home equity lines of credit) are both forms of home equity debt. The chart below compares important features of HELOC loans with the most popular type of reverse mortgage: the Home Equity Conversion Mortgage (HECM).

The comparison is based on general traits for each type of loan and is not intended to provide specific information about any particular lender or product. Terms and conditions can vary widely – particularly for HELOC loans. You should always check with lenders to get the most up to date information before making any borrowing decision.

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There are times when a HELOC (or other traditional home equity loan) is preferable to a reverse mortgage for extracting home equity for retirement cashflow purposes:

1. When There is a Good Chance the Homeowner Will Not Stay in the Home for at Least 5 Years – Simply put, a reverse mortgage is a very expensive type of loan if the homeowner moves out or dies during the early years of the loan. If it is likely you will not be in your home for at least 5 years, you are better off borrowing via a home equity line of credit (HELOC). With a HELOC there are typically small (even zero) closing costs to consider; the downside is that you must make a monthly payment to the lender. For the first 7-10 years of the loan, you will need to pay only interest on the amount you’ve actually borrowed. Another downside of a HELOC is that you will need to show the lender that you have the financial wherewithal to make the monthly payments. It is possible for a short period to make the monthly payments by drawing against the HELOC (i.e. borrowing more to make loan payments), but for longer periods this will not work.

2. When You Don’t Want Your Options Limited – Even if you don’t think you’ll be moving within 5 years, you may want to keep your options open. The decision to take out a reverse mortgage is also a decision to limit your options in couple of ways. First, as noted, you need to stay in the home long enough to spread the high closing costs out over time for the loan to be sensible. Second, depending on interest rates, home values and other factors, the rising debt of a HECM will eat into your home equity and limit future financial flexibility. The same factors are at work with a HELOC loan, but you have more flexibility to refinance – even into a reverse mortgage product – at a later date.

3. When You Are Too Young or Too Old – Age matters a lot in the reverse mortgage arena. Although HECMs are available to senior homeowners age 62 and older, the “best” age for reverse mortgage borrowers seems to be about 75. This is an age at which you can get a decent loan amount and still have enough years to left smooth out the impact of fees. The amount that can be borrowed is largely determined by actuarial life expectancy tables – the younger the borrower, the longer his or her life expectancy and the less the amount of the loan. Fees, however, generally are not age dependent. As examples, using the , loans were computed for a sample $200,000 home for a single homeowner at three ages:

62-year old – Estimated fees are $14,782 or 14.7% of the computed loan principal amount (before fees) of $99,954. This homeowner could receive a monthly tenure payment of $494 as long as he stayed in the home.

75-year old – Estimated fees are $14,130 or 11.7% of the computed loan principal amount (before fees) of $120,842. This homeowner could receive a monthly tenure payment of $708 as long as he stayed in the home.

85-year old – Estimated fees are $13,100 or 9.5% of the computed loan principal amount (before fees) of $137,933. This homeowner could receive a monthly tenure payment of $1,078 as long as he stayed in the home.

Thus, the younger person suffers from both a relatively paltry available loan amount and because fees – as a percent of the loan amount – are inordinately high. The 85-year old seems to “win” on both these counts, but only because his life expectancy is relatively short. Moreover, there is a greater chance that an 85-year old will need to permanently leave the home on an unplanned basis for assisted living.

4. When There is a Big Age Difference Between Homeowners – The reverse mortgage calculations are always based on the age of the youngest homeowner. Thus, for a 75-year old homeower with a 62-year old spouse, the age used to calculate a HECM loan will be 62. Moreover, if the spouse is under age 62, the reverse mortgage option won’t even be available unless the home is re-titled in the older spouse’s name only.

5. When Tax Deductible Interest is an Important Consideration – Interest on a home equity conversion mortgage (HECM) is not deductible until paid – i.e. when the house is sold or the homeowner dies. Interest on a HELOC, however, is paid every month and – if you itemize deductions – is deductible in the year paid. Some seniors with taxable earnings or retirement income (IRA, 401k, etc.) may find it more advantageous to borrow through a HELOC rather than a HECM for this reason.

When you take out a traditional mortgage or home equity loan, the lender is concerned with two primary factors: 1) the value of the property you are borrowing against and, 2) your regular income and ability to make payments on the loan. Often senior citizens have no problem meeting the first qualification. Indeed, many have fully paid off their primary mortgage and own their home free and clear.

However, the regular income factor is another matter. Many seniors receive little more than social security income on a regular basis. These are the “house rich and cash poor” seniors. Their houses are worth money and, perhaps, even paid for, but they don’t have enough cash to maintain them — or enjoy their retirement years. For people in this situation, it is difficult to qualify for traditional home equity financing.

In contrast, reverse mortgages are intended to help “house-rich” but “cash-poor” elderly access additional income to meet expenses, and to assist middle-income senior homeowners convert their home equity into liquid assets. The borrower’s income and credit worthiness are not of concern because payments are made from the lender to the borrower – i.e. reversed – rather than from the borrower to the lender.

Part of the reason closing costs seem high for reverse mortgages is that you are paying for government mortgage insurance – insurance that guarantees no matter how long you live or how much the reverse mortgage loan balance increases due to rising interest rates or other factors, you will never owe more than the value of your home. The reverse mortgage is unique in that it has no set date for repayment – the loan is due and payable only when the homeowner sells or dies.

Simply put: you can not outlive a reverse mortgage nor can you be forced to sell your home to pay off a reverse mortgage.

With a standard mortgage or home equity loan (including HELOC), you have specific requirements to make monthly loan payments and a specific due date when you must pay back the entire loan balance. Failure to meet these requirements will cause the lender to take action to protect their interest, up to and including foreclosure proceedings.

Interest on a reverse mortgage “accrues” over time but is not payable until the homeowner sells or dies. With a HELOC loan, minimum monthly interest payments (and, at some point, principal repayments) begin the first month after the loan is taken. Thus, while you can initially increase monthly cash income by drawing down equity through a HELOC, this will be at least partially offset by increased loan payments.

For example, the interest-only monthly payment on a $10,000 HELOC loan balance would be $56.25, or $675.00 annually.

As money is drawn out for living costs, the loan balance grows and the required monthly payments also grow. Eventually, you will be using borrowed funds to make monthly payments and risk running out of money.

For shorter periods (under five years), using a HELOC may be preferable to a reverse mortgage because of the higher upfront fees. But for longer periods, the reverse mortgage will be the better mortgage tool for supplementing retirement income.