November 26, 2018 by HECM Pro
If you’re like many seniors, you might have refinanced your mortgage in the past few years to take advantage of low interest rates.
You may also have chosen a fixed 30-year mortgage because of the low payments. That’s not a bad choice, but here’s the kicker: when does that loan pay off? Sometime after the year 2040 perhaps? If so, that means you could spend the rest of your life paying on that mortgage and still never pay it off.
Why do that if you have better options?
Believe it or not, there is a way to get rid of the payment now, without having to pay off the entire balance. The strategy I’m going to show you is not perfect for everybody, but for the right candidate it can be a game-changer.
Let me introduce Alice, a 68-year old retired banker. Her husband passed away a few years ago, so she’s living on her Social Security, a small pension, and the IRA she built up over many years of working. Her Social Security and pension don’t quite cover all her expenses, so she’s been withdrawing $800/month from her IRA to make up the shortage.
Alice is comfortable, but she’s on a tight budget and can’t splurge because it will drain her IRA faster. She wants to make sure that money lasts at least as long as she does.
She enjoys her home and has no plans to sell anytime soon. She’s also not worried about leaving her home to her kids because they all have their own homes and are doing well.
Alice has a 30-year fixed mortgage that she refinanced in October 2014. The starting loan amount was $150,000 and the interest rate is 3.75%, which means her principal and interest payment is $695.
Alice can afford the mortgage payment, but she’s essentially draining her IRA (and paying income taxes on the withdrawals) to pay a mortgage payment. Even worse, she’s got 24 years left on the loan! She’ll be 92 when she makes her last mortgage payment. She might last that long, but it’s a sure deal her IRA won’t. She’s really worried about running out of money.
Folks, Alice is essentially flushing money down the drain – the I-may-not-even-live-long-enough-to-pay-off-this-mortgage drain. What’s the point of paying on a mortgage you may never even pay off anyway? Even worse, why drain hard-earned savings to pay that mortgage? It’s throwing good money after bad!
There has to be a better way, right? Fortunately, there is!
A better option
Before I explain what I have in mind, let me first mention who this strategy is not for. The financial tool I have in mind is great, but like any financial tool, it’s not perfect for everybody.
If you plan to sell and move in the next few years, I recommend holding off until you get settled into your new home. I also recommend holding off if your priority is to leave the maximum possible home equity to your heirs.
However, if you’re retired and have a lot of years left on the mortgage, you don’t plan to sell anytime soon, and you’re not worried about leaving equity to your heirs, then pay close attention to what I’m about to tell you. I’m going to show you how you can stop flushing money down the drain on a mortgage you may never pay off anyway.
Let me introduce the federally-insured and regulated home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). The HECM is a specialized mortgage product that allows you to get rid of your mortgage payment once and for all without having to pay off your current balance.
Look at it like a refinance; you’re basically refinancing your existing mortgage into a new mortgage that doesn’t require a payment. As long as at least one borrower is living in the home and paying the required property charges, no monthly mortgage payments are required.
You always retain title ownership of the home and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in the home.
If for some reason the home isn’t worth enough to settle the entire balance, FHA will step in and pick up the shortage. You won’t roll over a debt to your heirs even if home values fall.
The HECM is a mortgage, so it has an annual interest rate like any other mortgage. Rates are usually pretty comparable to traditional 30-year fixed mortgage rates. If you choose not to make a mortgage payment (which is the whole point, right?), interest just accrues onto the loan balance over time.
The equity in your home is essentially making the mortgage payment for you. You no longer have to make the payments out of your pocket! This means you now have more money to spend on more important things, like grandchildren, home improvements, vacations, or just living expenses.
How it works
To see how this works, let’s get back to Alice. Assuming her home is worth $375,000, Alice qualifies for a HECM principal limit of $159,750 with an interest rate of 5.32%. When the annual mortgage insurance of 0.50% is added, the total interest rate is 5.82%.
The HECM eliminates the $695 mortgage payment and offers Alice an extra reserve account (the line of credit) she can dip into in case of unexpected expenses, such as home repairs or medical bills.
More importantly, Alice can now stop drawing down her IRA – at least until she has to start taking required minimum distributions. She no longer needs the $800/month because she no longer has a mortgage payment. This preserves her IRA and reduces her annual income tax bill.
Alice is no longer flushing income and savings down the drain on a mortgage she may never pay off!
Let’s fast forward ten years and see where things are at. Assuming rates don’t change and Alice doesn’t make a mortgage payment or tap into the line of credit, the HECM balance will have grown to $287,972. Her available line of credit will have grown to $13,761.
As you can see, Alice’s loan balance has grown substantially in the ten years since she’s had the HECM. She’s added almost $136,000 to her loan balance. At first glance, that might sound terrible, but let’s not forget that Alice hasn’t made a mortgage payment for ten whole years. Her total cumulative mortgage payment savings is a whopping $83,400.
That’s $83,400 that she’s been able to keep in her pocket and spend on more important priorities. Instead of throwing $83K at a mortgage she’ll probably never pay off anyway (and drain her IRA in the process), she’s had that money to spend on her grandchildren, home upgrades, a cruise to the Bahamas, etc.
Even better, that’s $83,400 that she didn’t have to drain from her IRA. She’s at far less risk of running out of money, which gives her immense peace of mind.
Mortgage payments aren’t inevitable
Folks, it’s not inevitable that you spend the rest of your retirement years throwing money at a mortgage that may outlive you. The HECM is a fantastic program that can get you out of “jail” early! It’s not perfect for everybody, but it’s a fantastic solution for many.
If you have many years left on the mortgage, you don’t plan to sell, and you aren’t worried about leaving equity to your heirs, the HECM could help you get rid of your mortgage payment years (or decades?) early and free up cash for more important things.