Should this reverse mortgage borrower modify or refinance?
Jane took out a HECM reverse mortgage on her house five years ago when she became 62. Because she was still employed at the time, she elected to take a credit line, which she has used sparingly ever since. She has now quit her job and wants to receive the largest possible payment every month -- a "tenure" payment, which is paid for as long as she remains in her home.
Jane has options. She can modify her HECM by converting her unused credit line into a tenure payment. But she can also refinance, taking the largest possible tenure payment on a new HECM.
Jane wants to know which of these monthly tenure payments would be larger. She may also want to know which option will cost her estate the most.
Refinancing and modification are alternative ways of changing the features of a mortgage. With a refinance, the changes occur by terminating the old contract and executing a new one. With a modification, borrower-initiated changes occur within the existing contract between borrower and lender. That contract must include provisions that make modification possible.
Both forward and reverse mortgages allow borrowers to refinance without a penalty, and in both cases borrowers can modify the loan by paying down the balance. However, HECM reverse mortgages allow several other types of modifications that are not available on forward mortgages.
One type allows borrowers with an unused credit line to draw on it, either on a discretionary month-to-month basis or by taking a fixed monthly payment over some specified period. Other HECM modifications allow borrowers who are drawing a monthly payment now to increase it if the existing draw is less than the maximum, or to reduce the payment, or change the period over which it is drawn, or convert it (in whole or in part) into an unused credit line.
These options to modify a HECM mean that in some cases, modification and refinancing are competing ways to draw funds. This is the case with Jane.
Working in favor of the refinance option is that Jane is now five years older and the value of her house has increased, both of which command larger monthly payments. Working against the refinance option is that it involves a new set of closing costs, which reduces payments. A modification costs only $20. But knowing all this doesn't answer the question of which option will provide the largest payment.
To answer the question of whether modification or refinance would work better for the borrower, my colleague Allan Redstone designed a devilishly clever spreadsheet that is on my website for anybody to download and use. The spreadsheet has three parts.
Status: This part shows the status of the HECM now, and how it will evolve if the borrower neither modifies nor refinances. The borrower must enter the original features of her HECM from her file, and the most current features as shown in the latest monthly statement from her servicer. The spreadsheet will project the monthly payment, loan balance, unused credit line, property value and homeowner equity out to age 114.
Options to modify: In this part of the spreadsheet, the borrower indicates her cash draw and monthly payment desires, relative to the maximums available. The spreadsheet projects the same five measures as in the status section with the desired modifications included.
Refinance versus modification: This part projects the same measures on the assumption that the borrower refinances. Since these projections are heavily influenced by the price of the new HECM, the projections are done twice. One projection uses the new HECM with the lowest interest rate quoted by the nine lenders who deliver their prices to my website. The second projection uses the HECM with the smallest origination fee. These results are compared to those based on modification of the existing HECM.
The spreadsheet provides Jane with information not otherwise available. She could learn from her servicer what her new payment would be if she modified her HECM. She could learn from any HECM lender what her payment would be if she refinanced with that lender, but these results would vary from one lender to another based on their pricing. And neither her servicer or any lender she consults can show her differences in future home equity between the refinance and modification options.
• Contact Jack Guttentag via his website at mtgprofessor.com.