Q. I reached 62 this year and have a mortgage balance of $85,000 on my house, which is worth about $400,000. I plan to continue working and making my payment of $1,076 until the balance is paid off, which will be in another eight years. Or should I pay off the balance now with a reverse mortgage?
A. Your question is relevant to all the baby boomers now reaching 62 who have mortgage balances. My answer depends on which of the four groups I describe below best describes you.
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You want the largest amount of cash possible in the future: In your case, I define "future" to be eight years when your current loan will be paid off. If you take a standard Home Equity Conversion Mortgage (HECM) now at age 62, draw enough cash to pay off your current mortgage balance, and leave the balance as an unused credit line, the line will grow from about $149,000 to $222,000 in eight years at current interest rates.
If instead you stay on your current path and don't take a HECM until eight years from now when you are 70, your credit line will be about $252,000 at that time. If your property appreciates over the eight years, the credit line will be larger. However, this comparison ignores the fact that if you wait eight years rather than take the HECM now, you must continue making monthly payments of $1,076. There are no required payments on the HECM.
To make the two scenarios roughly comparable, we must assume that if you take the HECM now, you set up an investment account into which you make the same monthly payments. Then we compare the credit line plus investment account in eight years if you take the HECM now with the credit line in eight years if you delay taking the HECM until then.
The outcome of this comparison depends on the appreciation rate if you delay, and on the short-term investment return on your monthly payments if you take the HECM now. I have looked at numerous combinations of these variables, and most of the plausible ones favor taking the HECM now.
For example, if we use an appreciation rate of zero and an investment rate of 1 percent, which is roughly the current situation, the credit line plus payment savings if the HECM is taken now will be about $329,000 as compared to a $252,000 credit line if you wait. The proviso is that you are able to continue making the same payments you would have made if you delayed.
You are currently payment-burdened: Your objective in taking a HECM now could be to relieve yourself of the current payment burden, in which case you have no interest in continuing to make the payments. You want the HECM to relieve financial stress now.
You need budgetary discipline: You might belong to the group of homeowners who can save only by positioning themselves so they have no choice. This population includes people who buy merchandise under layaway plans, those who deliberately overwithhold on their income taxes, and many mortgage borrowers. If you want to set aside $1,076 every month but realize that you will probably fail if the payment is optional, you will stay with your current mortgage that requires the payment. The HECM can wait.
You like to actively manage your cash flow: You might belong to the group of people who actively manage their accounts, usually because they have fluctuating incomes. They are not chronically payment-burdened and don't require external discipline to save when they have the money. What they particularly value is having a ready source of additional cash when they need it and a safe place to park excess funds when they have them.
They get both if they convert their existing mortgage balance into a HECM balance, with the remainder of their HECM borrowing power taken as a credit line. They can tap the credit line when they need funds, and they can use surplus funds to pay down the balance. The return they earn when they pay down the HECM balance is the mortgage rate plus the mortgage insurance premium, and in addition, the portion that is applied to interest is a deductible expense.
In sum, with the exception of those who need the discipline imposed by required mortgage payments, seniors reaching age 62 with a mortgage balance would do well to convert it into a HECM balance. Just make sure you convert the remainder of your borrowing power into an adjustable-rate credit line that will serve you in the future. Do not convert the balance into a fixed-rate HECM that requires you to withdraw cash (that will leave you with nothing down the road) unless you need the cash to save a life now.
• Contact Jack Guttentag via his website at mtgprofessor.com.
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