Most seniors in the market for a HECM who are still carrying
a mortgage balance view the HECM as their way of ridding
themselves of a monthly payment. If there is an existing
mortgage balance, enough cash must be drawn from the HECM to
pay it off. However, some senior homeowners have enough
financial assets to pay off the balance before they take the
HECM, if it makes financial sense to do that. It turns out
that whether or not it makes sense may depend on where the
homeowner goes to get the HECM.
I look at the question through the eyes of a 62-year old
with a house worth $400,000 that has an existing mortgage
balance of $100,000. I assume that the owner wants the
reverse mortgage that provides the largest possible monthly
payment for as long as she lives in the house – a “tenure
payment”. If she pays off the $100,000 balance before taking
the HECM, the monthly payments on May 27 ranged from $970 to
$1143, based on quotes from 6 lenders that report HECM
prices to my web site. If she does not pay off the $100,000
balance beforehand, the available payments from the same
lenders range from $453 to $618. The payments are lower in
this case because the HECM is using part of the senior’s
borrowing power to pay off the existing balance.
Using the highest of the monthly payment quotes, the
difference between the two cases is $1143 - $618 = $525.
Paying off the $100,000 balance before taking the HECM
increased the tenure payment by $525, but the borrower would
lose the income she was earning on the $100,000. To match
the $525 increase in the monthly payment, the $100,000 would
have to yield 6.3% after-tax and risk-free, which is
possible but not very likely. While this leaves the $100,000
capital value intact, that is largely offset by the lower
future HECM loan balance of the borrower who pays off the
balance beforehand. After 8 years, she will owe $86,000
less.
A cleaner comparison assumes that in the case where the
$100,000 mortgage balance is paid off by the HECM, the
borrower would use the $100,000 of financial assets to buy
an annuity. On May 27 I priced an immediate life annuity on
$100,000 for a 62-year old man at $498, which is not that
different from the $525 difference in tenure payment,
considering that a life annuity can go on a little longer
than a tenure payment. From a cash flow perspective, it is
about a draw. That leaves the lower HECM loan balance of the
borrower who pays off the balance beforehand as a net
benefit of that option. That may or may not be important to
the borrower, depending on her attitude toward bequests to
her survivors.
There is one other potential benefit to paying off a loan
balance before taking a HECM. The range of payments quoted
by lenders is twice as large when the HECM pays off the
balance than when the borrower pays it beforehand. $618 is a
whopping 36% higher than $453 while $1143 is only 18% higher
than $970. The larger spread in the first case reflects the
greater profitability of a HECM with a large initial loan
balance, which provides greater pricing latitude and results
in a wider range of price quotes.
The wider range of price quotes doesn’t matter if the
borrower can shop effectively for the highest payment. To
see whether it was possible to shop individual lenders on
line, I checked the web sites of 15 HECM lenders including
the 5 largest. Only one of them, All Reverse, displayed
tenure payments and future debt. I stopped my inquiry at 15,
but if any of the lenders I missed provide this information
on their web sites, they can let me know and if it checks
out, I will add their names to the web version of this
article.
The alternative for senior
homeowners is to access the database covering multiple
lenders on my web site, selecting the highest payment, just
as I did. Borrowers who get locked into one lender are
rolling the dice and will do better paying off the balance
before taking the HECM.