FHA insured reverse mortgages, called HECMs, allow seniors
to withdraw cash from their home while retaining the right
to live there indefinitely. They are a potentially powerful
tool for helping seniors live better lives during their
retirement years, and new HECM options enlarge the
However, the benefits can also be frittered away, with little lasting benefit to the senior, and all too many seniors are doing just that. When this articlde was first written, about 2/3 of all HECM borrowers were withdrawing the maximum amount of cash possible at closing, which left the senior with no borrowing power for the future. While some seniors have compelling reasons for withdrawing the maximum amount of cash at the outset, many were making a mistake.
Late in 2013,
HUD changed the rules to limit upfront cash draws, because
they viewed cash-draw HECMs as a source of loss to the
insurance reserve fund.
mistakes that seniors make is the complexity of HECMs and
the fact that few seniors understand them. The new options
increase the complexity. While there is no way to make HECMs
simpler, or to raise the IQs of senior borrowers, the
likelihood of bad decisions can be reduced by improving the
quality of advice that they receive, and the quality of the
information to which they have access.
borrower must be counseled by a HUD-approved HECM counselor,
but counselors are not preventing borrowers from making
serious mistakes. Even if counselors were financial planners
qualified to advise seniors on how a HECM fits into a
retirement plan, which most are not, under HUD rules,
counselors are not supposed to recommend one HECM option
over another. Many HECM borrowers, furthermore, turn off
their hearing aids during their counseling session.
the most serious deficiency in the counseling process is
that it does not occur until the borrower has contacted a
loan provider, which in most cases indicates that they are
committed to taking a HECM, even if the details are not yet
finalized. Many, perhaps most, have pressing and immediate
financial problems. Their numbers are small relative to the
millions of seniors who do not have pressing problems, but
whose lives might nonetheless be improved with a HECM.
larger group of seniors are not aware of what a HECM might
do for them, their information is likely to be limited to
what they have heard in advertisements or solicitations, to
which they understandably react with caution and suspicion.
While there are places they can go to obtain unbiased
information , including this site, most are not aware of
such resources, many don’t use the internet, and they are
not being driven by financial need to take any action. They
represent a potential market of enormous size that is not
HUD limits the
origination fees that borrowers can be charged to 2% of the
first $200,000 of property value, plus 1% of the amount
above $200,000 but with a cap of $6,000. In addition,
lenders collect a yield-spread premium paid by the
wholesalers to whom they sell the HECMs. On the day in July
that I checked, these premiums were 7.625% on fixed-rate
standard HECMs, and 4.875% on standard adjustable rate
HECMs. Premiums are paid on the initial loan balance only.
Thus, a senior
of 72 with a $400,000 home will generate premium income for
the lender amounting to $20,600 if he draws maximum cash on
a fixed-rate mortgage; $13, 200 if he draws maximum cash on
an adjustable-rate mortgage; and $600 if he elects an
annuity on an ARM. In the last case, the initial loan upon
which the premium is based consists only of the financed
settlement costs. The bottom
line is that lenders have a strong incentive to encourage
borrowers to withdraw cash upfront. Unfortunately, in many
cases, borrowers don’t need much if any encouragement.
homeowners had one or more forward mortgages during their
life, from which experience many emerged with a bias against
ARMs. They may not have had one, but they heard about them
and knew that they were risky. So when offered a choice of
fixed or adjustable rate HECMs, they opt for the fixed,
which requires that the full value of the HECM be taken in
against ARMs combined with lender financial interest in
maximum cash withdrawals make for a perfect marriage. But
not one made in heaven.
against HECM ARMs is misconceived. On forward mortgages,
borrowers are exposed to the risk that a future interest
rate increase will make the monthly payment unaffordable,
but there is no such risk on a HECM because borrowers have
no mortgage payment to make.
increase in the rate on a HECM does result in a more rapid
increase in the senior’s loan balance, but this only hurts
borrowers who use all or most of their borrowing power by
drawing cash at the outset. To the extent that the senior
reserves some part of his HECM borrowing power as an unused
credit line, future ARM rate increases work to his benefit
because the line grows at that rate.
The upshot is
that seniors with needs best met by an annuity payment,
and/or by husbanding a credit line for future use – which is
most of them -- should not shrink from taking an ARM.
are complicated, we live in an information age replete with
sophisticated tools for expositing complicated ideas. Lucid
exposition of the full implications of each possible course
of action can overcome a borrower’s preconceived bias and
the entreaties of interested loan originators.
The tools available to HECM borrowers, however, are a sorry lot. The existing calculators focus entirely on how much the borrower can draw, without any supporting information on the future consequences of a given selection. So I decided to develop my own. See Calculate Your HECM Reverse Mortgage Options.