A prevalent myth about reverse mortgages is they drain home equity, leaving little to nothing left for heirs upon the death of the borrower. This misconception, which may ultimately deter some eligible borrowers from participating in the Home Equity Conversion Mortgage (HECM) program, requires some myth-busting to set the record straight.
While a HECM necessarily reduces the home equity that becomes available to the borrower’s estate, in most cases it does not absorb all the equity, writes Jack Guttentag, a.k.a The Mortgage Professor, in a recent article.
“Furthermore, and this is the critical point, seniors have discretion with regard to the amount of home equity that is used to meet their own needs, and the amount that is retained for their heirs,” he writes.
Many borrowers, however, do not use that discretion, Guttentag notes, because they do not know how their selection of HECM draw options will affect the equity that will remain for their heirs.
Assuming a 65-year-old senior with a debt-free home worth $400,000, Guttentag provides several scenarios to demonstrate the impact of certain HECM disbursement options and how they affect borrowers’ potential to leave remaining home equity.
In Case 1, the borrower has enough income to meet her recurring needs, but is worried she may face heavy medical expenses later in life. So she selects a credit line, and after 10 years, the line has grown to $376,000, at which point she owes only $10,000—consisting of her HECM settlement cost, plus 10 years of interest—according to Guttentag’s calculations.
“Parenthetically, this use of a HECM as an insurance policy against unknown contingencies has got to be the best bargain available in financial markets,” Guttentag writes. “If the senior never has to use the policy, all her home equity except the inconsequential amount she owes on the HECM will go to her heirs. And if she does need to draw on the credit line to pay her bills, no one will question the decision.”
But say this borrower has significant unmet needs right now and draws the maximum amount of cash available to her at closing, which is $124,460, based on The Mortgage Professor’s “Kosher HECM” calculator.
“This sizable advance results in a significant loan balance, which reduces but does not eliminate the home equity that will become available to her heirs,” Guttentag writes. “If she dies after 30 years, her estate will owe $509,000 but it will realize $1.3 million on the sale of the home.”
Read more at The Mortgage Professor.
Written by Jason Oliva