Kiplinger Magazine: Are Reverse Mortgages Risky for Boomers?

Baby boomers may have more reverse mortgage options today than in the past, but they still need to “do their homework,” writes a Kiplinger magazine article published in its September 2012 issue. 

Looking into the trend of younger borrowers tending toward fixed-rate, lump-sum reverse mortgages, Kiplinger notes the newer, Home Equity Conversion Mortgage (HECM) Saver, and explains the credit line growth concept as what may be a preferable option for some. 

Kiplinger writes

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“… younger borrowers taking lump-sum loans could lead to big problems. In 10 or 20 years, with the compounding of interest, little or no home equity could remain. Many borrowers may not be able to raise enough funds from a home sale to move to a retirement community or an assisted-living facility. Or they could run into trouble if they’re short on cash for health expenses, home repairs or property taxes in later years — traditional uses of late-in-life reverse mortgages. “There may be some folks who will struggle,” says Megan Thibos, a policy analyst at the Consumer Financial Protection Bureau and author of its report.

For extra cash, a borrower could refinance the existing reverse mortgage, says Peter Bell, president of the National Reverse Mortgage Lenders Association. But more money may be available only if the home value rises or interest rates drop. The borrower’s older age would help provide a boost.

Besides wanting the payout, many younger borrowers are choosing a lump sum because it offers a fixed interest rate. The line of credit and monthly-draw options require an adjustable rate, which generally comes with a 10% cap.

According to All Reverse Mortgage’s online calculator, a 62-year-old borrower with a $400,000 home could take a fixed-rate Standard loan with no fees at an interest rate of 4.99% and get a lump sum of $250,000. After nearly $12,000 in fees are wrapped in the loan amount, the same borrower could get a credit line of $238,050 at an initial adjustable 2.48% rate.

But while a fixed-rate loan may be fine for a regular mortgage, the interest on a reverse mortgage eats into home equity. With a fixed-rate reverse mortgage, the lump-sum loan starts accruing interest from the start. On the $250,000 lump-sum example above, in ten years that balance will climb to $465,841. Assuming 3% home price appreciation, that would leave about $72,000 in equity based on the home’s $537,566 value. In 20 years, the loan balance would reach $868,031, exceeding the home’s $722,444 value.

Borrowers may be better off with the adjustable-rate loan and its flexible payout. With the line of credit, you only accrue interest on the amount you tap. Any unused amount grows at the loan’s rate….

Read the original article in full.

Written by Elizabeth Ecker

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  • These are some of most childish financial concepts I have read.  

    What does it matter if interest eats into home equity or eats up available cash?  Both have the same result, a reduction to the overall estate; however, cash payments of interest are unrecoverable except for HECM adjustable rate loans.  With HELOCs, interest payments may be recoverable but one has to deal with the overall amount of money available through the loan, whether it will be renewed or perhaps even frozen.

    Or how about the sophomoric notion of equity?  No one knows where equity will be in ten or twenty years. The value of our home more than tripled in one decade before it was cut by 30%.  So it went from a quarter of a million dollars to about $800K before falling to the mid $500K range.  Over thirteen years that is still better than a 6% average appreciation rate when compounded annually and that is through what is generally considered as the worst part of the Great Housing Depression.

    All real estate is local.  Or is commonly stated, the three overriding rules about the value of real estate is first location, followed immediately by location, and bringing up the rear, the greatest rule of all, LOCATION.    

    If a senior got a reverse mortgage today from most lenders, a drop in the interest rate would NOT result in more proceeds based on current principal limit factor tables.  Almost all HECMs are being originated with expected interest rates below 5.07%.

    Where the article is right is that seniors should invest time in looking over HECMs and seniors with relatively low balances due at funding would probably be better served with an adjustable rate HECM than a fixed rate HECM product.

  • Comparing the fixed rate, lump sum HECM to a forward, adjustable rate Line of Credit is nice information but is the proverbial apples to oranges comparison. Why not compare the HECM saver line of credit with the forward line of credit? Both are low cost and interest doesn’t accrue until you use the money. With the HECM, if you use the money you don’t have to worry about a growing, interest-only  monthly payment or the balloon payment which will be coming at yeaer 10.

    • Donnw,

      Let us stick to a comparison of the adjustable rate HECM to a HELOC.

      But is it all about cash payments?  If that is all it is then one could make an argument about drawing down the HELOC line of credit to make payments and refinancing after 10 years.  In essence creating your own reverse mortgage.

      Besides the LTV on the forward HELOC can be much higher than on a HECM.  

      But that is not what it is all about.  The HECM line of credit cannot be frozen, closed, reduced, and is guaranteed to be transferred intact if anything happens to the lender.  Then there is the potential growth in the available HECM line of credit.

      But the biggest drawback are the higher upfront costs of a Saver (unless there is no origination fee) and its 1.25% FHA MIP accrual on the UPB.

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