The public is still unaware that the federally-insured Home Equity Conversion Mortgage (HECM), commonly referred to as a “reverse mortgage”, can be used to purchase a home. Even those that are familiar with this option are unaware of its various strategic uses.
Nevertheless, the “HECM for Purchase” product was created eight years ago to assist older homeowners with relocating. Thus, older homebuyers can purchase a home and obtain a reverse mortgage in one transaction, nearly eliminating the additional closing costs a second transaction would bring.
This week, I attended the National Reverse Mortgage Lenders Association annual meeting in Chicago. It was there that a few of us shed some light on this HECM for Purchase product.
Most “HECM for Purchase” homebuyers use all 100% of their Principal Limit at closing, using every penny toward the sales price of the home and closing costs. This is generally because the Fixed Rate HECM option requires funds to be utilized one time only (at closing). Essentially, the buyer is borrowing as much as they can, in part, because they don’t want to “leave money on the table.”
While leveraging all the HECM funds upfront makes sense from a CASH position, many homebuyers are unaware that with an Adjustable Rate HECM, unused funds may be set-aside in a secure line-of-credit (LOC) to be used for emergency purposes.
For example: If the borrower qualifies for $200,000 and only uses $120,000, the ARM products allow the remaining $80,000 to remain in a secure, and growing, line-of-credit.
In fact, with an ARM, any voluntary payments the borrower chooses to make reduces their loan balance, AND boosts their LOC further. This available LOC then grows at the same rate as the loan balance, regardless of future property values.
Consider an ARM, and only use 60% of the HECM funds at closing
This is a strategy I call “Over-Funding the Purchase”. It is a way to purchase a home and enhance future financial planning options at the same time. Borrowing less, requires a larger investment into the purchase of the home. This doesn’t sound appealing until you examine the following additional advantages:
Reduced Initial Mortgage Insurance Premiums (IMIP)
If homebuyers limit their up-front use of available HECM funds to 60%, instead of 100%, they have the advantage of paying only 0.5% of the Max Claim Amount* to the Federal Government in Initial Mortgage Insurance Premiums. This is a significant reduction from the traditional 2.5%.
*Note: The Max Claim Amount on a HECM for Purchase is the lesser of the appraised home value, the sales price of the home, or $625,500.
Increased liquidity after one year
When using this strategy with the ARM products, the remaining 40% (that was not used at closing) is allocated to a growing LOC and may be accessed after the first year of the loan. With annual LOC growth rates in the 5%-6% range, this strategy can improve a homeowner’s liquid reserves over time.
When examining a financial instrument used to purchase a home, the conventional wisdom is that the borrower should either leverage as much financing as possible, or simply pay for the home in cash. I disagree, and Over-Funding the Purchase offers a lower-cost alternative to these extreme options.
In addition, attention is rarely given to the financial planning implications of the HECM for Purchase option. Nevertheless, it can be used strategically to enhance retirement cash flow AND provide an emergency fund for contingencies that occur later in life.
To learn more about the prudent use of a reverse mortgage, buy my book, Understanding Reverse, and subscribe to this blog.