Three Scenarios

  • September 26, 2014

A reliable and easy-to-use calculator that can improve the ability of seniors to determine whether or not their lives would be benefited by a HECM (Home Equity Conversion Mortgage) reverse mortgage. However, having a tool is one thing, knowing how to use it effectively is another.

This article illustrates how the HECM calculator can be used to determine whether or not a reverse mortgage would work for each of three seniors who have very different types of needs.

Senior Long anticipates possible needs well into the future, Senior Short has pressing needs right now, and Senior Medium, who is more typical, has both present and future needs.

There are three ways to draw funds on a HECM: as upfront cash, as a monthly payment, and as an unused, growing credit line. Through a process of trial and error with the HECM calculator, a senior finds the option or combination of options that best meets his or her needs. Then they can compare the funds that can be drawn with the total settlement costs and decides whether the benefits are worth the cost. Lurking in the background is a likely (though not certain) loss of equity in the home over time, which may or may not be relevant to any senior.

I would not suggest that a potential HECM borrower attempt these calculations and interpretations alone.  There are just too many variables and interconnecting factors.  Some basic information is readily available, but interpretation and implementation needs to be left to an expert who can work along beside the potential HECM user.

Senior Long is 79, has a house worth $400,000 with no mortgage balance, and has no immediate need for additional funds. But Mrs. Long is concerned that the nest egg from which she draws her living expenses will become depleted while she is still alive – – she will outlive her money. She wants protection against that contingency.

The HECM calculator indicates that on September 25, 2014, Mrs. Long could obtain a credit line of $254,737 on an adjustable rate HECM with a margin of 2.25%. If left untouched, the line will grow every year at a rate equal to the current interest rate plus the annual mortgage insurance premium. If her nest egg becomes fully depleted while she is still alive, she can begin drawing on her unused line. As an illustration, if the interest rates on September 25, 2014 continue unchanged, the unused line will be $474,667 ten years later when she hits 89. If rates increase in the future, the available line will be larger.  Many HECM borrowers with a nice line of credit are secretly wishing for inflation!

The ratio of available funds without the credit line growth to financed settlement costs of $4463 is 57 to 1. I view this as an easy decision, because even if Long wants to leave as large an estate as possible, the HECM will absorb very little if any of the equity in her house unless and until she outlives her assets and begins to draw from it..

Our lady Mrs. Long could also set up a monthly check while maintaining that line of credit.  The funds not withdrawn continue to grow.  And she can change the distribution method as often as she chooses to as life circumstances might dictate.  She has a lot of options and with the right design and setup for her HECM this is a no-brainer.

Senior Short is 65, his house is worth $200,000 with a $98,000 mortgage balance, and because his income has declined, he is having difficulty making the mortgage payments. The HECM calculator shows that a fixed-rate HECM will allow him to pay off his existing mortgage, eliminating the payment burden, but he will have only 3000 in cash after all expenses.  Further, the ratio of available funds to upfront settlement charges is only about 13.5 to 1, which makes it a more costly transaction.  The key difference in relative costs is the requirement for a 2.5% upfront FHA insurance premium for him as opposed to the .5% that Mrs. Long enjoyed because of her very low debt to equity ratio.

So this is a tougher call.  Mr. Short and I would explore whether or not there was another source of funds that would allow him to continue making payments on his existing mortgage for a few more years. That choice is rare, and is in all probability just staving off the inevitable.  If he could pull that off, he might do better in the future and the proceeds from a reverse mortgage might pay off his current mortgage and leave him more cash.  That scenario is not likely.  Why is that?

First, the HECM available to him at that future point may bear little resemblance to the program today.  HUD is sending a loud and clear message that the program is being tightened, not expanded.  Qualifications are due to change before 2014 ends and a significant number of elderly Americans who are eligible today will not qualify.  Secondly, as interest rates rise (anyone out there think they won’t?), the available proceeds go down rather sharply.  On August 4th of this year new HUD policy accelerated the decrease in available funds as interest rates rise.

So the trend is clear.  We hope that there is a viable HECM program for Mr. Short in a few years if he can hang on but it’s a bet I would not make.  Because there is a solution now that eliminates his payments and increases cash flow and he does not need cash at the settlement table; that is probably his best option if he wants to stay in the home.

Taking the HECM now is arguably better than eating dog food or losing the house to foreclosure as he foolishly but understandably struggles to hang on to the detriment of his happiness.  This is a situation where I would ask a lot of questions and carefully judge the quality of life before and after using a HECM.

One logical recommendation may be to simply sell the home.  But emotion is far more powerful than logic.  Usually when I bring up the option of selling I get a dirty look.

Senior Middle is 75 with a house worth $400,000 and an existing mortgage balance of $80,000. The HECM calculator indicates that on September 25, 2014 she could have paid off the $80,000 balance and had a credit line of $161,137 on an adjustable rate HECM with a margin of 2.25%.  Ms. Middle would like to reserve only about $40,000 for future use but wants $10,000 in cash now to pay off some other debts, and would like as large a monthly payment as possible for as long as she is in the house.

When she enters $1,000 as a desired monthly payment, the calculator indicates that her maximum lifetime (tenure) payment is $990, and this would leave nothing in her credit line. So she confirms a 10,000 cash request and a growing line of credit of $40,000.  This produces a $729 monthly check for the rest of her life.

The bottom line for Middle is that she can draw $10,000 in cash, $729 a month for as long as she lives in the house, and have a $40,000 credit line in reserve that will grow every month that it is not used.  At age 85 Ms. Middle will have $75,000 available to her. The present value of the funds she can draw is 36 times larger than the settlement costs of $4463.  That’s quite a value.

This is actually an easy decision for Ms. Middle.  When we look at the amortization schedule for her scenario we see that the depletion of equity is very slow while she is enjoying a $10,000 “bonus”, an extra $729 monthly and watching her $40,000 line of credit grow to $75,000 in 10 years!

You can play with some numbers at my web site:

Remember that some of the factors in these scenarios are estimates.  Also, rates and programs change frequently and the most accurate projections are found in an amortization schedule created in real time.  That’s easy to do.  Just call Bob at 703-475-1555 or email me at [email protected].  Please provide the age of the youngest borrower, the home value and any mortgage balance/s currently on the home.

There is no obligation of course.  You’ll get facts not a sales pitch!