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Reverse Engineering

Mike Roberts

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.

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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.

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Nate Allen
Nate Allen
2 months ago

Why do these recent articles on reverse mortgages always come across as sales pitches?

Last edited 2 months ago by Nate Allen
Mike Roberts
Mike Roberts
2 months ago
Reply to  Nate Allen

With respect, don’t confuse enthusiasm with a sales pitch. I freely acknowledge that a reverse mortgage is not perfect for everybody. I’ve written plenty of content over the years explaining when people should not get a reverse mortgage.

mytimetotravel
mytimetotravel
2 months ago

Sounds like a solution in search of a problem. (Or a finance industry in search of fees.) How many 68 year olds need more house than they already have?

DrLefty
DrLefty
2 months ago
Reply to  mytimetotravel

I actually started thinking how this could work well for us. We’re 62 and not yet retired. If we stay in our current home, which has a mortgage and maybe $350K of equity, we could take out a modest refi reverse mortgage if we needed cash for something. Might not be worth it.

But if we wanted to move elsewhere, we could sell, take some or all of our equity to pay into the “purchase” version, and have no payment. In our case, it might be worth it to unlock the equity from our old home and use the reverse mortgage provisions (now that we’re old enough to quality) to make our new home more affordable for us in retirement.

Mike Roberts
Mike Roberts
2 months ago
Reply to  DrLefty

That is exactly the idea! The reverse mortgage for purchase enables you to keep more of your cash in the bank instead of sinking it into home equity to buy a home outright and avoid a mortgage payment. Or, it can help increase your purchasing power as well. Mortgage payment is often the limiting factor when buying a home, so if that can be taken out of the way, it’s easier to spend a little more if you need to on the purchase price.

parkslope
parkslope
2 months ago

I appreciate learning about finance alternatives, although statements like “one of the mortgage industry’s best-kept secrets” always raise my anti-sales pitch guard.

High initial mortgage costs increase the time period one needs to own a property to make it worthwhile which I suspect is why a 20-year example was used in this article. However, I can’t help but wonder how many folks purchase a house at 68 and live in it for 20 years.

Mike Roberts
Mike Roberts
2 months ago
Reply to  parkslope

Thanks for reading! Anybody who knows me personally knows I’m not a “sales pitch” kind of guy. I really do think it’s a best kept secret. Almost nobody knows you can purchase a home with a reverse mortgage. Of those who have heard of it, few actually know how it works or how it can be advantageous.

Peter Blanchette
Peter Blanchette
2 months ago

Excellent column! I have interviewed 5 or 6 financial advisors over the years. Not one ever mentioned the use of a reverse mortgage when I gave them every opportunity to recommend one based on my situation that I informed them of. Do you know why this is? I know that the sales charge is a little high for many people. But you have very thoroughly explained why this is and how it is offset over time. I believe that the % of eligible seniors who use RM is in the single digits only.

Mike Roberts
Mike Roberts
2 months ago

Many people are skeptical of reverse mortgages because of how they used to work. Reverses have improved significantly over the years. Others just don’t understand how it works. Financial advisors are probably not going to recommend something they don’t understand well because of their fiduciary duty to their clients.

wtfwjtd
wtfwjtd
2 months ago

I’d say the reason people in general avoid using reverse mortgages is mainly simple math. Using the author’s example above, the borrower “Betty” has $120,000 of equity at the end of the 20 year term. If, OTOH, she had financed that $200,000 loan conventionally, and paid the $257,674 of principal and interest payments over the 20-year term, she would be left with a home equity value of $464,770– a substantial difference. One should think long and hard about whether this is an acceptable trade-off, obviously.

Mike Roberts
Mike Roberts
2 months ago
Reply to  wtfwjtd

You raise a good point, but don’t forget that different people have different goals. When you’re not retired yet, you’re building your assets for retirement. What you said makes sense – you want to limit interest costs and build equity as quickly as possible. Once you’re retired, you’re trading the assets you’ve built for the retirement lifestyle you want. In retirement, it’s all about the monthly cashflow. It often doesn’t make sense to take on a monthly mortgage payment and limit your retirement lifestyle simply because you’ll have more home equity in 20 years than you would with a reverse mortgage. Many retirees have no plans to sell and move. They don’t care how much equity they have. What matters is how much money they have every month to spend on fun things and absorb unexpected emergencies.

Peter Blanchette
Peter Blanchette
2 months ago
Reply to  wtfwjtd

Few people are going to do the financial transaction you talk about here. I am referring to using the RM as a means of providing additional liquidity during retirement.

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