Yearly Archives: 2017

Don’t Confuse Me With Reverse Mortgage Facts

I can understand why there are reverse mortgage skeptics. The product is unfamiliar to most, and confusing to others. Unfortunately, no number of charts, mathematical calculations, HUD guideline references, or even my book, will ever change the minds of many that need to experience it to believe it. Like many in my industry, I must continually defend my profession to a public that often disagrees with me, but without the facts to make an educated decision.

An interesting conversation in a hotel lobby last month highlighted this defense:

Stranger: “So what brings you to San Diego?”

I’m here discussing Home Equity Conversion Mortgages, what many call “Reverse Mortgages.”

“You do know that reverse mortgages are a scam, right?”

Well, surveys show that nearly 90% of customers say they are “satisfied” or “highly satisfied” with their decision. That is extremely high for a financial product. Scams have near-zero satisfaction ratings.

“But the bank gets your home.”

That’s the most common misconception. The homeowner holds title to the home, and when they die, the home still belongs to the estate.

“Ok, but all the equity is gone, so that’s the same as losing your home.”

Actually, research indicates that most borrowers today gain equity in their first year. From there, it is generally up to the borrower to determine if they wish to consume all their equity over time.

“Ok, but the fees are so high, and you can’t defend that”

When you say “high”, to what product are you comparing? All forms of insurance and retirement cash flow have costs. Draws from a 401k are taxable, but draws from home equity are not. The fees are similar to traditional FHA loans, but the reverse mortgage offers so much more in future security. Some find the growing line of credit to be a less expensive way to fund future in-home care. In fact, others have saved more in taxes than the costs.

“You have no idea what you are talking about.”

Actually, I’m here teaching a course on this topic, and I wrote a popular book on this topic.

“Well then, you should be in prison making license plates.”

I didn’t have the heart to tell her that most states no longer allow prisoners to make license plates. Of course, some people don’t want to be confused with the facts.

When I stopped chuckling, I typed the conversation into my phone to share with my class the following day. Of course, we all had a good laugh. However, it is sad that, like many baby boomers, she hit four of the Top 10 misconceptions in a two-minute conversation, yet she continues to reject a product that was created specifically for her generation.

For more information on the strategic uses of the reverse mortgage product, please purchase Understanding Reverse – 2017 and subscribe to this blog.

Dan Hultquist

The Ideal Reverse Mortgage Candidate May Surprise You

You see it all the time – articles about reverse mortgages that begin with “They are not for everyone”, and then the author describes an ideal scenario. Sadly, many perfect candidates won’t consider a reverse mortgage because misinformed authors and consumer advocates have painted the wrong picture of the product.

Some phrases that are inaccurately used to describe the model applicant include:

  • Older homeowner
  • Cash-strapped or desperate
  • Last resort
  • House rich – cash poor

These are descriptions of traditional “needs-based” reverse mortgage borrowers. However, with the regulatory reforms of the last four years, these borrowers are now a smaller portion of the three primary uses described in my book.Of course, with any reverse mortgage applicant, we want to make sure it is their intention to remain in their home – preferably through retirement. But it may surprise you that the following may be qualities of an ideal reverse mortgage candidate today:

  • Age 62
  • Still working
  • Has about 5 years to pay on their forward mortgage
  • May never need to access the funds

Let’s look at each characteristic and why the product may be advantageous to them:

Age 62

62 is the earliest age a homeowner can obtain a reverse mortgage. Obtaining one early maximizes the line-of-credit (LOC) growth potential of the product. Telling someone to wait to get a reverse mortgage is like telling a 35-year-old to postpone saving for retirement. This is because the available funds in the guaranteed line-of-credit will experience compounded growth. These funds are expected to grow at approximately 6.25% annually, but compound monthly. At that rate, a $200,000 line of credit would grow to nearly $700,000 in 20 years, regardless of the home’s value. This LOC grows tax free, and may be drawn tax free, which unlocks many strategic options at age 82.

Still working

Many will claim the greatest advantage of a reverse mortgage is that “there are no required monthly principal or interest payments.” I would counter with, “for those that are still working, the ability to make optional payments is a greater advantage.” For those that can make payments, a reverse mortgage loan balance will drop in a similar way as a forward mortgage. However, each payment also boosts the LOC for future use.

Many pre-retirees are faced with a decision – should I accelerate payments on my forward mortgage to reduce my loan balance before retirement OR should I save additional funds for retirement cash flow. Making payments with a reverse mortgage accomplishes both objectives at the same time.

Has about 5 years to pay on their forward mortgage

Those that only have a handful of years to pay on their traditional mortgage or Home Equity Line of Credit (HELOC) naturally have low payoff amounts. If the lender can payoff those balances and closing costs, and use 60% or less of the borrower’s initial benefit amount, the initial insurance premium drops from 2.5% (generally of the property value) to 0.5%. This is an extremely low initial fee for any government-insured loan product.

For those that are carrying a moderate loan balance on their reverse mortgage, the interest rates are still expected to be relatively low for the next few years. Ideally, the borrower would make payments during the first few years to reduce the loan balance. After that, the homeowner will benefit from higher interest rates, as the available LOC will grow faster.

May never need to access the funds

The LOC works very well as an emergency fund, a “stand-by”, or even an insurance policy. There are initial costs. But the on-going costs of the loan are based on the funds that are borrowed. In other words, if the borrower never needs the funds, the carrying costs of the growing LOC may be very low.

Imagine having a loan balance of $1,000, and a LOC of $200,000. The loan balance is expected to grow only $65 in the first year. However, the homeowner can raise their deductibles on every insurance policy they hold. They can now self-insure. This reduces expenses and raises monthly cash flow. In addition, the homeowner can draw less in taxable monthly retirement income.

 

Of course, this is only a partial list. We haven’t begun to discuss the many financial planning implications. For example, those who do not qualify for, or cannot afford, long-term care insurance are great candidates as the home can fund future in-home care. Those that wish to relocate, upsize, or downsize, can keep more of the gains they receive from the sale of their existing home by using a HECM for Purchase.

Years ago, I wrote that when I turn 62, I WANT a reverse mortgage. Do I plan to be a cash-strapped, house rich – cash poor, desperate older homeowner? Of course not. The financial planning advantages are too strong to ignore when the benefits are properly understood.

 

For more information on strategic uses of the reverse mortgage product, please purchase Understanding Reverse – 2017 and subscribe to this blog.

Dan Hultquist

Waiting Comes at a Cost with Reverse Mortgages

Many financial planners are now recommending reverse mortgages, as they have finally begun to recognize the strategic uses of home equity as a retirement planning tool. Sadly, however, many will consider the product only once their other retirement funds are depleted. This “last resort” tactic has shown to be less than optimal in academic studies by Barry Sacks, Wade Pfau, John Salter, and others. When you begin to understand the dynamics of the federally-insured Home Equity Conversion Mortgage (HECM), you’ll find that waiting often doesn’t make sense.

WAITING SIMPLY DOESN’T PAY

In 2015, I wrote a piece titled Waiting Simply Doesn’t Pay. In the blog, I made the following statement:

“If you only have a basic understanding of Reverse Mortgages, then waiting appears to be the right advice. After all, older borrowers get more money, right? If I wait 5 more years, not only will I be older, but my home will be worth more, and I will have paid down my forward mortgage. These may seem like logical reasons to wait… to the novice.”

I went on to explain the following three reasons why it doesn’t pay to wait:

  1. Reverse Mortgage proceeds are based on interest rates. When rates go up, new applicants may have access to much less of their home equity.
  2. Waiting sacrifices compounding line-of-credit (LOC) growth. The LOC growth is maximized by obtaining the reverse mortgage early and letting time do its work.
  3. There is no guarantee one will qualify in the future. Financial Assessment has made it harder to obtain a reverse mortgage at a time when you are more likely to need it.

What I didn’t explain in my previous blog is that the costs and benefits of waiting are easily quantifiable.

WHAT IS THE INCREMENTAL BENEFIT OF WAITING ONE YEAR?

Even if the HECM program remains unchanged, and expected rates stay low (rounding to 5.0% or lower) in the future, the incremental benefit of the client being one year older, averages less than 1% more in principal.

Consider a 67-year-old homeowner who wishes to wait another year when he or she is 68 years old. As you can see below, waiting one year would yield an increase in the homeowner’s calculated Principal Limit Factor (PLF) of 0.6%.Principal Limit Factors are tables, created by HUD, that determine how much a lender can offer a homeowner at the time the loan closes. In this example, a 67-year-old homeowner with a $200,000 home might have access to $111,200 at the time of closing. All other factors being equal, waiting one year yields this homeowner an increase of 0.6% or $1,200 more in principal.

If the home appreciates by 4% during this time, the homeowner would have access to 56.2% of that appreciation by waiting. Another way to express this is that a “home gain” would be another 2.2% (56.2% of the 4% increase).

This net gain of 2.8% is nice, but small when compared to the expected growth in the homeowner’s principal limit if they obtained the HECM at age 67 instead. This is because Principal Limits (for existing clients with adjustable rate HECMs) rise each year by the current interest rate plus 1.25%.

At the time of this publication, a lender margin of 2.75% plus the 1-yr Libor index shows an initial interest rate of 4.522%. When 1.25% is added, the Principal Limit growth for the same borrower during that year would be estimated at 5.772% or $6,418.

Clearly, the PLF increase is small when delayed, and the borrower has lost some of the compounding potential of the product.

WHAT IF INTEREST RATES GO UP?

To determine a homeowner’s initial Principal Limit, we use “Expected Rates”, which is the market’s best estimate of future rates. As long as expected rates round to 5% or less, the borrower will receive the maximum principal limits for their age. In the example above, we established that a borrower at age 67 today can qualify for 55.6% of a home value of $200,000.

However, if long-term rates rise to 6% while waiting, this could yield the homeowner much less in principal.

A 1% increase in expected rates would probably drive the lender margins lower to stay closer to 5%. Otherwise, waiting one year could decrease principal limits from 55.6% to 43.6%. That is a reduction of 12% or $13,344 in this example.

Incidentally, if the HECM had been secured, any future interest rate increase could be beneficial, if that homeowner holds most of his/her funds in the growing LOC.

While we don’t want to create an unmerited sense of urgency, clients need to be aware that research shows that waiting for a reverse mortgage generally isn’t optimal. NOW may be the best time to obtain one.

For more information on the strategic uses for Reverse Mortgages, please subscribe to this blog and purchase my book, Understanding Reverse-2017.

Dan Hultquist