Mortgage Professor: Are Borrowers Missing on Reverse Mortgage Bang for Buck?

Some reverse mortgage borrowers don’t make the right choice when it comes to the loan options presented to them, while others simply aren’t aware of the consequences of their choices in the long run, writes The Mortgage Professor (a.k.a. Jack Guttentag) in an Inman News article this week.

The second in a new series of reverse mortgage-focused articles, Guttentag hones in on borrowing power of seniors: how they can maximize the benefit of a reverse mortgage.

“The different HECM payment options can be viewed as different ways that seniors can use the borrowing power of their homes. Total borrowing power depends on the property value, the age of the youngest co-borrower, and the expected interest rate and upfront fees on the HECM. The senior can use her borrowing power to withdraw cash, purchase an annuity, reserve a credit line that grows larger as long as it is not used, or some combination of the three.

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 …The different options have different implications for the growth of mortgage debt. All the options result in the same debt when the borrower reaches age 100, but prior to that longer annuity periods result in smaller debt growth.

For example, after five years, the debt of the senior who took the largest possible tenure annuity is only one-third as large as the senior who withdrew the maximum amount of cash. This means that if the borrower dies early, her estate is substantially larger if she had taken the tenure annuity. Further, assuming she lives on, she can convert her lower debt in the early years into additional borrowing power by modifying her program, a point discussed below.

The article details different scenarios that are available and takes a look at the loan balance that accrues over time. Ultimately, the Mortgage Professor advises taking the minimum amount that is needed upfront and reserving the alternative options for the future, especially in the case of younger borrowers. 

Read the original article at Inman News or the Mortgage Professor’s website

Written by Elizabeth Ecker

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  • Dr. Guttentag and I exchanged several emails on the computations he made in the initial stage of the article.  Even though the corrected computations are still a little off in places, they are much better than when he started.

    In the emails I chose not to address other issues in the article he wrote.  For example, when he enters into the area of personal finance is obviously outside his league in saying:  “For example, after five years, the debt of the senior who took the largest possible tenure annuity is only one-third as large as the senior who withdrew the maximum amount of cash. This means that if the borrower dies early, her estate is substantially larger if she had taken the tenure annuity. Further, assuming she lives on, she can convert her lower debt in the early years into additional borrowing power by modifying her program, a point discussed below.”

    Why does a lower balance mean a larger estate?  Let’s take a look where the opposite is true.

    Say a borrower with a home appraised at $400,000 takes out a HECM adjustable rate HECM in late November 2008 with a margin of 2%.  Let us say the principal limit was $300,000 and the net principal limit was $283,500.  The borrower uses $33,500 to pay off credit cards.  The borrower dies in November 2012 when the home was worth just $320,000 due to a  drop in the value of his home from both the general downturn in home values and a tornado that took several homes in his neighborhood in early fall 2012 which has yet to start final cleanup and rebuilding.

    In Scenario One, the borrower never took any more proceeds and never paid down the loan.  So on the date of death, the total value of his estate was $520,000 (including $200,000 in fully vested retirement assets) with the HECM having a balance due of $56,366 (average interest rate 2.5% and MIP at an annual rate of 0.5%).  All other debts including medical net of Medicare reimbursements were $3,634, making a net estate of $460,000.  

    In Scenario Two, the facts are the same except the borrower took the additional $250,000 out of the line of credit and bought a Muni bond which matured the day before he passed away and had an effective interest rate of 4%, compounded annually with a single payout at maturity of $292,465.  In this case the value of all assets including the proceeds from the matured bond are $812,645.  The balance due on the the HECM as date of death was $338,198 for total debts of $341,832, making the net estate in this case $489,011.  Now some may jump up and say that the math is wrong because the difference between $812,645 and $341,832 is only $470,813; however, the balance due on the HECM exceeded the value of the home by $18,198 so the most that was required to be repaid was only $320,000, making the net estate $18,198 larger or $489,011.

    Thus by taking all of the proceeds early (Scenario Two), the net estate is actually $29,011 greater.  Even if someone decries that the total accrued expense rate on the HECM was too low in the Scenarios, the net estate in Scenario Two would remain the same while the net estate in Scenario One would only be smaller.  Yes, it is as easy to make a case that the net estate would be smaller by taking all of the proceeds upfront but again that would require a disclosure of the use of the funds and the impact of that use on the estate as of date of death.  But the key to the illustration made is that use of the proceeds alone added $10,813 to the net estate no matter if the value of the home as of date death is too low or the accrual rate on the HECM is too high.  Of course some might argue that the interest rate on the Muni bond was too high or some combination of factors which includes the earnings on the Muni bond BUT that is an argument for another day.

  • Guttentag’s error is in inductive reasoning: he makes the assumption that a particular asset (net home equity) is equivalent to the total value of all the assets of the borrower (the net value of the estate). As the song lyric goes, “It ain’t necessarily so”. Some of us could add real-life scenarios where good use of the flexible payout options of a HECM ARM have helped to preserve or even enhance a borrower’s net worth.

    Mr. Guttentag’s larger point that borrowers may choose less advantageous payout options remains a key and current point of discussion and research, and one that is relevant because it touches upon many aspects of our business for us and our critics.

    • Mr. Peters,

      You state:  “Some of us could add real-life scenarios where good use of the flexible payout options of a HECM ARM have helped to preserve or even enhance a borrower’s net worth.”  But how do your “real-life” scenarios demonstrate two different outcomes using only one set of facts?  The two scenarios demonstrate that a higher HECM balance due does not necessarily mean a lower net estate.  Does that require a “real-life” example?  Beyond that using a strong fictional example means absolutely no disclosure of confidential information.  But if you have an example that makes a better case showing the difference, please do so.

      You then go on to say:  “Mr. Guttentag’s larger point that borrowers may choose less advantageous payout options remains a key and current point of discussion and research, and one that is relevant because it touches upon many aspects of our business for us and our critics.”

      What in the world are “less advantageous payout options”?  I do not remember reading about any such thing.  What I do remember reading is criticism that fixed rate HECMs offer no payout “options” and because they are closed end mortgages, there is no way to access their “lines of credit.”  All one can do is pay down the balance due but once done, the use of that cash is lost unless (and until) the mortgage is refinanced with a principal limit equal to the principal limit on the existing HECM as of the date of funding of the refinance plus all closing costs.   

      The real problem most critics and detractors have with HECMs is the use of the funds by borrowers.  Many critics of the fixed rate product believe that borrowers with less than masterful money management and investment skills are far too many times forced into making less than positive use of those funds on a long-term basis, i.e., for four years or more (the average half-life of a HECM).  While generally concurring, that also seems a very compelling reason to have hybrid HECMs.

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