The Home Equity Conversion Mortgage (HECM) is a complex program offering prospective borrowers a variety of options when choosing the best reverse mortgage that fits their needs. While this is a “major strength” of the HECM program, it can also be a “weakness,” according to a recent column from Jack Guttentage, a.k.a The Mortgage Professor.
“Multiple options make the program complex, which opens the door to poor decisions that can be costly,” Guttentag writes in an article published by The Herald of Rock Hill, S.C.
To provide prospective borrowers a roadmap for the decisions they must make when getting a HECM, Guttentag offers four to help seniors find the reverse mortgage that best meets their needs.
For the first step, Guttentag suggests consumers enter their information into a reverse mortgage calculator, inputting criteria such as the borrower’s age, house worth, existing mortgage balance (if applicable) and how long the borrower expects to hold the reverse mortgage.
Step two comes down to choosing between a fixed-rate or adjustable-rate HECM, knowing the differences between each product and how they impact the amount of reverse mortgage proceeds the borrower can be eligible to receive.
Gutentag illustrates a scenario of prospective borrower John Doe, who is 68 years old, has a home worth $500,000 with an existing mortgage balance of $170,000, and who expects to have the reverse mortgage about 10 years.
With a fixed-rate HECM, the most Doe will be able to draw—in addition to the $170,00 balance payoff—is $32,000, Guttentag notes. WIth an adjustable-rate mortgage, Doe could draw $32,000 at closing and then another $105,000 after 12 months. Under the ARM product, Doe could also elect to draw funds monthly or take a line of credit as his other options.
“In sum, anyone who wants to draw funds in the future will select and ARM,” Guttentag writes. “The only seniors for whom an FRM makes sense are those who have an immediate need for funds that can be met with the FRM, and want to minimize their loss of equity.”
The sub-step of Step Two then becomes deciding between a 0.5% mortgage insurance premium and a 2.5% premium. The higher premium, Guttentag notes, applies to transactions on which the borrower uses 60% or more of his borrowing power upfront to either draw cash or pay off an existing mortgage.
Per the scenario, the $32,000 that Doe could draw upfront was based on the 2.5% premium, whereas with the 0.5%, he could draw only $15,000.
“Those who select an FRM might elect the higher premium because of the larger cash draw,” Guttentag writes. “In contrast, those who select an ARM because of their interest in future draws, will not find the higher premium option of any value because it reduces monthly payments and future credit lines.”
Step three comes into play when selecting the ARM option and deciding between a cash draw upfront and then taking additional proceeds 12 months later; obtaining a line of credit; tenure or term payments; or even a combination of these methods.
The final step for prospective reverse mortgage borrowers is selecting the best combination of interest rate and origination fee.
Guttentag offers an example of a lender who quotes a rate of 3.776% and an origination fee of $3,000, and also a rate of 3.901% and an origination fee of negative $5,042—a rebate.
“Which set is better for the borrower depends on his objective,” he writes. “If it is to minimize his loss of equity, he wants the price combination that results in the lowest loan balance at the end of the period he expects to have the mortgage.”
Read The Herald article.
Written by Jason Oliva