WHAT IF I SAID YOU could borrow to buy a home and have no mortgage payment? Would you think I was nuts?
Trust me, I’m not. If you’re age 62 or older, it’s possible to finance a home purchase and have no ongoing mortgage payments. How? By taking advantage of a home equity conversion mortgage, or HECM. The federally insured HECM is the most popular reverse mortgage in America today.
Now, I know what you’re thinking. Aren’t reverse mortgages just for desperate, penniless retirees? Not at all. The product has evolved over the years. Today’s reverse mortgage is safer and more versatile than those of the past.
Most people are familiar with the “refinance” HECM, which allows you to draw down equity in a home you already own. Fewer people know that you can also buy a home with what’s called a “HECM for purchase.” It’s one of the mortgage industry’s best-kept secrets.
The HECM for purchase requires no mortgage payments as long as at least one borrower or non-borrowing spouse lives in the home and pays the property taxes and homeowner’s insurance.
You remain the owner of the home, which means you can leave it to your heirs. If your heirs want to keep the home, they might pay off the balance with cash or by taking out a conventional mortgage. If your heirs don’t want the home, they can sell it or let the lender sell it. Once the sale closes, the reverse mortgage balance is repaid and the remaining equity goes to your heirs.
The HECM is a non-recourse loan, which means you’re protected if your home isn’t worth enough to pay off the entire loan balance. The Federal Housing Administration covers any shortfall.
Here’s an example of how the HECM for purchase works: Let’s assume Betty, age 68, is buying a home for $400,000 and doesn’t want to have a mortgage payment. Most people qualify for a HECM loan amount equal to roughly half the home’s purchase price, so let’s assume Betty can borrow $200,000.
Betty is responsible for closing costs, which can be 3% to 5% of the purchase price. A good chunk of this is for the upfront mortgage insurance charged by the Federal Housing Administration. That insurance helps make the HECM for purchase a non-recourse loan. Let’s assume Betty’s closing costs are 4% of the purchase price, or $16,000.
If the bank finances $200,000, Betty will need to bring $216,000 to settlement—a $200,000 down payment plus $16,000 in closing costs. After closing, no mortgage payments are required as long as Betty lives in the home and pays the property taxes and homeowner’s insurance.
The HECM has an interest rate like any other mortgage. It also has a 0.5% annual mortgage insurance premium that helps make the HECM non-recourse. Let’s assume Betty’s interest and annual mortgage insurance add up to 5.5%. Again, no mortgage payments are required, so the unpaid interest and annual mortgage insurance are simply added to the loan balance over time.
How would her reverse mortgage look after 20 years? Betty’s outstanding loan balance will grow to $599,325. If her home has appreciated by, say, 3% annually, it will be worth $722,444—enough to pay off the mortgage and still have more than $120,000 of home equity.
Yes, the loan balance will grow substantially over the 20 years—but that’s how the HECM is supposed to work. Yes, Betty’s home equity has fallen from $200,000 to some $120,000 over 20 years. But that’s how she’s paying for a loan that has no monthly mortgage payment.
What if Betty instead finances the $200,000 she borrowed with a traditional 30-year mortgage at 5%? She’d pay $257,674 in principal and interest payments over 20 years. But with the HECM, that money can now be used for other purposes, such as home improvements, medical expenses and travel.
The HECM for purchase also makes it possible for Betty to buy a home and keep more of her money in the bank. Instead of paying $400,000 in cash to avoid a mortgage payment, she spent just $216,000. The reduced cash outlay means she holds on to more of her retirement savings, leaving her in better financial shape to enjoy retirement and cope with unexpected expenses.
Mike Roberts is a reverse mortgage industry veteran and the founder of MyHECM.com, a leading online resource about HECM reverse mortgages. Check out his site’s free reverse mortgage calculator. Mike’s previous article was You May Be Surprised.