One of the big HECM reverse mortgage disadvantages you may hear in the news media or read about online is that a reverse mortgage uses up the equity in your home quickly. Though this is a valid concern, it’s likely that a reverse mortgage won’t use up your equity as fast as you think. In fact, it may never use up anywhere close to all of the equity in your home; it just depends on what happens to home values in your area and how you use the reverse mortgage.
Access Equity While Preserving Equity
A HECM reverse mortgage is designed to give you access to your home equity while preserving equity as well. If it used up equity quickly, the HECM program would be financially unworkable because a HECM reverse mortgage is a non recourse loan, which means that the most that will ever have to be paid back is the value of the home. If there’s not enough value in the home to settle up the entire loan balance, then the FHA insurance fund covers the shortage.
Obviously, the insurance fund can’t always be paying out claims or it would quickly become a financial black hole for the federal government, so the HECM program was designed to be conservative. The idea was to give seniors access to equity while preserving equity for years into the future.
You’re in the Driver’s Seat
The reverse mortgage can be structured in many different ways – which is why it can be a powerful retirement planning tool. If your financial goals require that you use up more of your equity right away, then your remaining equity could be used up faster. On the other hand, if you need less of the money right now, then your remaining equity will be preserved for longer. How you use the reverse mortgage is ultimately up to you; the more you use, the faster your equity will decrease. The more you use, the longer your equity is preserved.
Putting Numbers on Paper
To illustrate just how well the HECM reverse mortgage can preserve equity, let’s look at a scenario where the borrower will be accessing as much of her equity out of the gate as she can. This means she’s starting off with a higher loan balance, which accrues interest faster than if she accessed very little equity at the outset. Consider this a a “worst case” scenario for equity usage because the initial loan balance starts off so high.
Let’s assume we’re working with a single 81-year old grandmother named Shirley who has a home worth $375,000 and a mortgage balance of $175,000 that is 26 years from being paid off.
Shirley has a decent retirement income, but because of her mortgage payment, some credit card bills, and the rising cost of living, she feels like she has nothing left at the end of the month. She really needs to get her expenses down so she can start doing more of the things she wants to do – like see her grandchildren. The years are flying by and they are growing up so fast and she wants to be able to see them and spoil them with gifts at Christmas and birthdays.
This is a great scenario to illustrate how a reverse mortgage preserves equity because it starts with a very large mortgage balance, which means it will accrue interest at a faster rate than somebody who starts off with a very small reverse mortgage balance. I want to show that even if you borrow the maximum allowed at closing, you’ll still likely have a healthy equity position in the home for many years into the future.
The reverse mortgage calculator shows that Shirley can pay off her existing mortgage and eliminate the mortgage payment (which saves her around $1,000/month) and access some additional cash, as follows:
- Cash/line of credit available at closing: $24,937.50
- Cash/line of credit available in 12 months: $33,512.50
- TOTAL available now and in 12 months: $58,450.00
She plans to take the full amount of additional cash available at closing ($24,937.50) to pay off credit cards and leave the remaining line of credit untouched when it comes available in 12 months.
According to the calculator, her closing costs look something like the following:
- IMIP: $9,375
- Origination: $3,750
- 3rd party closing costs: $2,800
Yes, her closing costs are pretty stiff because she’s paying off a large mortgage balance and falls under the higher IMIP mortgage insurance rate (2.50% of the home value) charged by FHA to insure the loan. FHA charges much more for the IMIP because there’s a higher risk Shirley could owe more on the home than it’s worth in the future. If that happens, FHA has to settle up the shortage out of the mortgage insurance fund if there’s not enough value in the home to pay back the entire reverse mortgage balance.
At least the closing costs don’t have to be paid out of pocket. Most lenders are fine with just rolling them into the new loan amount.
Here’s a summary of the numbers that add up to her starting loan balance:
- Existing mortgage payoff: $175,000
- Closing costs: $15,925
- Cash at closing to pay off credit cards: $24,937.50
- TOTAL initial loan amount: $215,862.50
Though Shirley incurred some stiff fees and this mortgage balance will accrue a good amount of interest if she has it for a long time, she’s still so much better off because she’s eliminated around $1,600 in monthly expenses between the mortgage and credit card payments. She is ecstatic because she now has the ability to spend the kind of money she really wants to spend on Christmas gifts for grandchildren. Even better, she can now afford to visit and actually see them open the gifts.
So, what happens to her equity? Does it get used up quickly because she started with such a large mortgage balance? Absolutely not!
Let’s assume that the total annual finance costs of the reverse mortgage are 5.1% on the loan balance and the property appreciates at a rate of 3% per year, which is a very reasonable national average over time.
If she lives to age 100, that means she’ll be in the reverse mortgage for about 19 years. As you can see in Figure 1, even after 19 years, she still has nearly $28,000 of equity in her home.
Though her equity is being used up by interest accruals, she’s saved $228,000 worth of mortgage payments over 19 years that would have otherwise been coming out of her retirement checks. Shirley figured she’d never pay off the mortgage in this lifetime anyway, so it made perfect sense to get rid of the payment and free up the income for more important things. After all, what’s the point of paying on a mortgage she’ll never pay off?
As you can see, though Shirley started with a large initial balance and accrued a lot of interest over the years, she still had a healthy equity position many years into the reverse mortgage.
Now, I’ll grant that this scenario may not be realistic for everybody. Not everybody lives in a real estate market where home values increase at a gradual rate of 3% consistently year after year. Some markets appreciate faster, others don’t appreciate at all, and still others seem to go through an endless cycle of boom and bust (lookin’ at you, Southern California). Ultimately it doesn’t really matter. What matters is that the reverse mortgage is designed to both give you access to your equity while preserving it for many years into the future- even if you use up most or all of your proceeds right out of the gate.
How Much Money Can I Get?
How much you qualify for depends on the value of your home, the age of the youngest borrower, and what program you select (fixed rate or variable rate). To get an idea of how much you might qualify for, check out our free, no-strings-attached reverse mortgage calculator.
