The Truth About Reverse Mortgages and Heir Legacy

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.

Advertisement

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

Join the Conversation (4)

see all

This is a professional community. Please use discretion when posting a comment.

  • A myth promulgated by many mortgage experts is the one that the Professor states in the following: “’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.”

    This is but an archaic and static view of home equity. One can to some degree control the amount of debt against a home at the extremes; however, if the interest rate is adjustable, that becomes harder. But that also ignores what is generally the most important component of home equity, home value. While homeowners can throw money into improving the value of the home, it is difficult to get a full return of the dollars spent doing so. Sinking assets into home improvements is simply shifting holding assets in one form into holding it in another.

    It was hoped that mortgage originators would come to reality after 2008 when home values dropped so dramatically and there was little that most mortgagors could do to retain their home equity. Apparently as seen in the quotation above, that inconvenient fact has once again been lost even among the most astute of mortgage academicians.

    What the Professor is trying to provide a clear picture of the value of prudence in mortgage borrowing when it comes to maximizing a net estate. Many times that is futile.

    For example, one client had a home worth $300,000 with no existing mortgage when getting the HECM. Some years later, about three years after the Great Recession, the debt against the home was about $28,000 and about $322,000

  • The chart is misleading in that the author never describes what interest rates are being used. In Case 1, it has an average effective interest note rate of 4.571%.

    In Case 2, the average effective interest note rate is about 3.258%.

    In Case 3, the expected interest rate is 3.8% which could happen but is reasonably unlikely in our current environment especially with most borrowers being charged margins of at least 3%. The average effective note interest rate is 3.823%.

    In Case 4, the expected interest rate is 3.008% which could happen but is highly unlikely in our current environment especially with most borrowers being charged margins of at least 3%. The average effective note interest rate is 4.32% for the first 10 years but about 3.78% thereafter.

    In Case 5, the expected interest rate is 1.387% which is impossible if the margin is 2% or more. What is actually being said is that available beginning line of credit cannot be $73,850 which it must be for the average effective note interest rate to be around 3.34%.

    The chart is not appropriate especially when insufficient assumption information is presented and appears to change for each and every case. The Mortgage Professor needs to increase his disclosure on how his numbers are computed. They seem too low in the current environment.

    • scary to see the margins charged to borrowers today. It appears lenders are charging the highest they can before it effects money available. especially when reverse mortgages used to have 0.5% MIP and 1% margins. This is why reverse mortgages are VERY expensive today.

  • It is troubling to still read the following from a recognized mortgage industry leader: ““’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.”

    While Guttentag does responsibly address prudence and its positive impact on the net estate of the borrower, he does not speak about the potential impact of adjustable interest rates and certainly does not give sufficient emphasis to the substantial part that home appreciation plays in home equity.

    It is hard to believe that in less than a decade, one would not strongly address what happened in 2008 and how much of that had to do with crashing home values rather than the lack of prudence of borrowers although in many cases that played a role even a substantial role.

    Too many times home value is viewed as static or only appreciating. 2008 proved otherwise. There are a number of moving factors when it comes to home equity.

    Home equity is truly dynamic. Viewing it otherwise could easily lead to false conclusions, poor decisions, and dynamic losses.

string(94) "https://reversemortgagedaily.com/2016/03/27/the-truth-about-reverse-mortgages-and-heir-legacy/"

Share your opinion