Future income replenishment with a reverse mortgage

The more I work with HECM reverse mortgages, the more convinced I become that it is the most underutilized financial tool available to seniors in the U.S. Among the important reasons for underutilization, HECMs are more complicated than any other financial instrument offered to retirees.

Reverse mortgages are complicated in order to meet a wide diversity of senior needs, but this poses the challenge of matching the individual senior's need to the appropriate HECM option or options. Many, if not most, seniors are not up to that challenge on their own, and the available decision support is poor.

• HUD offers virtually none.

• Lenders focus on doing deals; whether the option selected best meets the senior's long-term needs is incidental.

• HECM counselors do not offer advice on which reverse mortgage best serves the client.

• Many retirement planners do not even consider HECMs, and few that do have the expertise to advise seniors about which option or options would work best.

I have tried to fill this gap by writing articles on HECM uses, collecting current HECM price data from a group of lenders, and by developing a calculator that allows senior to explore their various options using live price data. I have begun to realize, however, that my calculator is easy to use for some applications, but difficult for others.

Ideally, the calculator should have a separate branch for each category of senior needs. I am going to illustrate this with one well-defined category of senior homeowner, which includes Jamie R.

Jamie is 62 and belongs to a rapidly growing category of people approaching retirement who have no pension other than Social Security, have paltry savings, but do have significant equity in a home. Because he also has a long remaining life ahead of him, Jamie plans to continue working until he reaches 70. At that point, his income will plummet and Jamie will want to replenish it, at least in part by drawing funds from a reverse mortgage. How exactly would he do that?

The best way involves using two HECM options. One option is a credit line, which is the right to draw cash for any purpose in an amount up to the total amount of the line. That amount rises over time so long as it is not used. The second option is a monthly payment, which can be for a specified number of years, or it could last as long as the borrower resides in the home - called a "tenure payment." A credit line can be used at any time to purchase a monthly payment.

Jamie's best strategy is to take a HECM credit line at 62, and let it sit unused until he stops working and wants income replenishment to kick in. At that point, he would convert the credit line into a tenure payment. During the intervening period, the unused line will grow at a rate equal to the interest rate on his reverse mortgage, plus the mortgage insurance premium of 1.25 percent.

Here is an illustration: I assumed Jamie's home was worth $400,000, and that he will want to replenish his income in eight years on reaching age 70. On May 18, for each of seven price quotes from the lenders who report their HECM prices to my website, I used my kosher reverse mortgage calculator to estimate Jamie's credit line in eight years, and the tenure payment the line would buy at that time.

The monthly tenure payments were as follows: $1,555, $1,557, $1,640, $1,722, $1,724, $1,748, $1,979. The range of $424 between the highest and lowest tenure payment is a reflection of how imperfect the HECM market is.

Would Jamie do just as well if he waited eight years and took out the HECM then? Probably not. If Jamie's home appreciated by 4 percent a year over the eight years, the lender who would eventually pay $1,979 if Jamie took out the HECM at 62 would pay $1,887 if Jamie waited eight years before transacting. The difference is that the unused credit line grew at 5.77 percent during the eight years rather than the 4 percent I assumed for property appreciation. Obviously there are scenarios in which home prices rise faster than interest rates, but they are unusual and unpredictable. In most cases, it will not pay to wait.

The bottom line in Jamie's case is the set of tenure payments in year eight. I was able to find the payments using my calculator, but the casual user probably would have difficulty. The calculator does not have a separate branch geared explicitly for those looking to replenish future income.

But it will soon. It will also have branches for other categories of senior need, which I will be writing about in future weeks.

• Contact Jack Guttentag via his website at mtgprofessor.com.

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