One of the important ways in which reverse mortgages differ from forward mortgages is the difference in the urgency to proceed. A prospective home buyer who needs a mortgage to make the purchase is under the gun to have the mortgage approved and fully processed before the sale date. In contrast, senior homeowners contemplating a reverse mortgage have no deadline to meet and can be as deliberate and careful as they want. Having the opportunity to consider all options without feeling pressured is a good thing. But it can be a bad thing if the conditions that affect the terms of the reverse mortgage for which they qualify change in an unfavorable way while they are waiting.
The purpose of this article is to indicate the kinds of changes that can affect the reverse mortgage available to prospective borrowers who wait for a while before making the plunge. A rational decision to proceed or to wait should be based on a clear understanding of these factors.
My test case is a homeowner of 62, the minimum age for reverse mortgage eligibility, with a home worth $200,000 and no existing mortgage. On July 4, 2016, she could have obtained a credit line of $99,420, a monthly payment of $551 for as long as she lives in the house, or a payment of $1098 for 10 years. If she waits for, say, three years, three things will change.
We know this with complete certainty. We also know that if everything else stays the same, her credit line and monthly payment draws will be larger. For example, her credit line will increase to $103,020, or by 3.6%. If her existing needs are not pressing, that supports a decision to wait.
Most houses appreciate in value most of the time, but not all the time. In modelling the HECM reverse mortgage market, HUD assumes that home prices on balance will appreciate by 4% a year. Using that assumption over a 3-year wait, the senior’s credit line will grow to $116,312, or by 17%. This reflects the combined effect of the borrower being three years older and her property appreciating by 4% a year over 3 years. Monthly payment increases would be similar. Although she cannot be as certain that her house will appreciate as she is that she will be older, in most cases the prospect of appreciation strengthens a decision to wait before taking out a reverse mortgage.
My surmise is that many seniors with a latent interest in reverse mortgages intuitively understand that delaying a decision while they grow older and their house appreciates will work to their advantage. What they are less likely to understand is that a rise in interest rates can easily torpedo their plans, while there is no possibility that a decline in rates will benefit them.
To summarize, a starting credit line of $99, 420 for a senior of 62 with a $200,000 house would increase to $116,312 by waiting 3 years, during which period the house appreciated by 4% a year. These credit lines were based on an adjustable rate mortgage with a start rate of 5%, which I assumed was unchanged over the three years. We now need to consider the implications of a change in market rates.
They are grim. Interest rate increases will have a large negative impact. If the rate goes from 5% to 6%, the credit line will drop to $94,715 or by 18.6%, wiping out the favorable impact of the borrower’s greater age and property appreciation. If the rate goes to 7%, the decline will be 36.8%. If the rate goes to 8%, it will be 51.4%. These are not unusual rates. I have had two mortgages in my life, one at 6%, the other at 8%, and I lived through an episode where rates hit 17%.
In today’s market, furthermore, the exposure of potential reverse mortgage borrowers to interest rates is completely asymmetrical. A decline in rates below 5% will have zero impact on the draw amounts available to borrowers. As the insurer of all HECM reverse mortgages, HUD determines draw amounts and it has set maximums at a rate of 5%. Future reverse mortgage borrowers will not benefit from a drop in rates, but they will lose big from an increase.
The benefit of delaying a reverse mortgage transaction is a small increase in draw amounts if interest rates stay the same or decline, while the risk is that even modest increases in rates will reduce draw amounts substantially. It might be prudent for seniors on the fence regarding whether they want a reverse mortgage or not to engage in watchful waiting. But for those who realize that a reverse mortgage will substantially enhance their lifestyle, watchful waiting is procrastination that could cost them dearly.
One further point: delaying the decision because the
need for funds won't arise for some years is a particularly
bad idea. Seniors in that position should take the HECM now
as an unused credit line. The line will grow so long as it
is not used at a rate equal to the mortgage rate plus the
mortgage insurance premium. That way, if market interest
rates rise, the reduction in draw amounts that result will
be at least partially offset by a rise in the unused credit
One further point: delaying the decision because the need for funds won't arise for some years is a particularly bad idea. Seniors in that position should take the HECM now as an unused credit line. The line will grow so long as it is not used at a rate equal to the mortgage rate plus the mortgage insurance premium. That way, if market interest rates rise, the reduction in draw amounts that result will be at least partially offset by a rise in the unused credit line.