Many home purchasers are seniors. Some become homeowners for the first time, but most have been and want to remain homeowners. They just don't want to remain in their current house. They may want a house that has no stairs, or one that is closer to family or friends, or in a warmer climate. In many cases, they want to downsize, both the physical house and the financial burdens that come with it.
Prior to 2008, the senior who wanted to combine house purchase with a reverse mortgage but could not afford to pay all-cash had to use a forward mortgage to finance the purchase, then repay it by drawing on a reverse mortgage. Because the senior had to qualify for the forward mortgage in the same way as any other home purchaser, an inability to document sufficient income or credit could bar the way. Furthermore, the senior who did qualify had to pay settlement costs on both the forward mortgage and the reverse mortgage.
In 2008, Congress authorized the HECM for Purchase program, under which seniors can buy a house and take out a HECM reverse mortgage at the same time. With this program, the qualification requirements associated with forward mortgages are avoided, and only one set of settlement costs is incurred.
The downside is that HECM reverse mortgages are more complicated than forward mortgages and present the senior with unfamiliar options. The purpose of this article is to clarify these options so that the senior can make the best possible decision,
A home purchaser who uses a HECM to fund part of the cost has 4 options. She can select either a fixed-rate or an adjustable-rate HECM, with the adjustable carrying a lower interest rate at the start but possibly a higher rate in the future. She can also elect to limit her cash draw to 60% of her maximum borrowing power, which qualifies her for the $1500 mortgage insurance premium, or she can draw more cash and pay a $7500 premium. Two times two equal 4 options, which I will illustrate with the case of a 66-year old purchasing a $300,000 home.
Option 1: Select a Fixed-Rate HECM With the $1500 Mortgage Insurance Premium: In this case, the purchaser could borrow $95,700 using the HECM, forcing her to find $204,300 somewhere else - presumably from liquidating assets. This is a one-time use of a HECM because the borrower retains no borrowing power.
Option 2: Fixed-Rate With $7500 Mortgage Insurance Premium: In this case, the purchaser could borrow $155,589 using the HECM, reducing the amount needed from other sources to $144,420. This remains a one-time use of a HECM. It differs from case 1 in allowing a larger cash draw, which results in a larger future loan balance, which carries a higher probability of loss to FHA, which is why the insurance premium is larger.
The borrower who wants to minimize asset liquidation, at the cost of higher future debt, will prefer Option 2 to Option 1.
Option 3: Adjustable Rate With $1500 Mortgage Insurance Premium: In this case, the cash draw is exactly the same as in Option 1, but in addition the borrower receives a credit line of $65,880 that is useable after 12 months. While the future HECM debt is lower than in option 1, that reflects the lower initial rate on adjustable rate HECMs relative to fixed-rate HECMs. A rise in market rates could turn that advantage into a disadvantage.
The borrower who wants to retain borrowing power in the future, at the cost of larger asset liquidation now, will prefer option 3 over option 2.
Option 4: Adjustable Rate With $7500 Mortgage Insurance Premium: This option is similar to Option 2 in that the borrower pays a higher mortgage insurance premium in order to obtain a larger initial cash draw. The difference is in future debt. Based on current rates, future debt will be higher in Option 2, but this could easily be reversed by future increases in market rates.
Bottom Line: If my major objective is to maximize my cash draw in order to minimize asset liquidation, I would select Option 2: the fixed-rate with $7500 premium. The lower current rate on Case 4 does not offset the risk of higher future rates. If I am comfortable with the asset liquidation required with the $1500 premium, I would select Case 3, the adjustable rate with $1500 premium, which provides a future credit line that is useable for any purpose, including the replenishment of financial assets.
A Caveat: The numbers shown in the table are based on the lowest prices quoted by the lenders who deliver their prices to my web site. Note that the origination fee is zero in all 4 cases. These lenders know that they are competing with each other. Seniors attracted by an advertisement who contact only the advertising lender face a significant probability that that lender charges the highest fee allowed by law. You can pin this down by using the HECM price checker on my site to compare your lender's prices with those of the competitive lenders on the site.
Options Open to a 66-Year Old Borrower Who Wants to Purchase a $300,000 House With a HECM Reverse Mortgage, As of June 20, 2016
|Mortgage Type/ Mortgage Insurance Premium||Interest Rate||Origination Fee||Cash From HECM/Remaining Cash Required||Credit Line After 12 Months||HECM Debt After 20 Years|
|Fixed-Rate/ $1500||4.5%||$0||$95,700/ $204,300||$0||$311,237|
|Fixed-Rate/ $7500||3.99%||$0||$155,580/ $144,420||$0||$468,644|
|Adjustable/ $1500||2.697%||$0||$95,700/ $204,300||$65,880||$268,294|
|Adjustable/ $7500||3.274%||$0||$155,580/ $144,420||$0||$428,956|
Visit my website to access the reverse mortgage calculator used in this article.