April 10, 2019 by HECM Pro
The reverse mortgage is a great product, but like any financial tool, it’s not always the perfect solution for everybody. Potential pros and cons and whether or not it’s right for you depends on your goals for the home.
Do you plan to stay in the home long term? Is it your “forever” home? How concerned are you about leaving equity to your heirs? Will you need your home’s equity at some point in the future for something else? Asking yourself these kinds of questions can help you decide if a reverse mortgage purchase loan is right for you.
Before we dig into some potential reverse mortgage for purchase pros and cons, let’s make sure we have a few basics covered first.
How a reverse mortgage works
The most common reverse mortgage in the United States today is the FHA-insured home equity conversion mortgage, or HECM (often pronounced “heck-um” by industry insiders). Other reverse mortgage products are available, but the HECM is the most dominant one by far. It’s the program I’ll be addressing in this article.
The HECM is normally used by seniors 62 or older to tap into the equity of a home they already own. Relatively few people know that the HECM can also be used to purchase a home.
The HECM for purchase program enables you to finance a home purchase without a mortgage payment. The bank finances a portion of the purchase price and you bring in the rest (plus closing costs) as your down payment. No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) is living in the home and paying the required property charges.
You always remain the owner of the home and you’re free to leave it to your heirs. Your heirs will inherit the remaining equity in the home.
The HECM is a mortgage, so it has an interest rate like any other mortgage. HECM interest rates are usually comparable to traditional 30-year fixed interest rates.
If you choose not to make a mortgage payment (which is the point, right?), the interest simply accrues onto the loan balance over time. Instead of you making the mortgage payment, the equity in your home does it for you. That means you have more cash to spend on things more important than making a mortgage payment.
Reverse mortgage for purchase pros and cons
In my opinion, the HECM for purchase is a great program. I think anybody who is willing to look at it honestly will come to the same conclusion. However, the HECM isn’t always a perfect fit for everybody. Let’s now cover some potential reverse mortgage for purchase pros and cons.
No mortgage payment
This is the first and most obvious “pro” – and it probably sounds almost crazy to some people. Seriously? Finance a home purchase with no mortgage payment?? Yet, that’s exactly how it works! The bank finances a certain amount and you bring in the difference plus closing costs as your down payment.
No mortgage payments are required as long as at least one borrower or non-borrowing spouse is living in the home and paying the required property charges.
Keep more cash in the bank
Normally, you have to buy a home outright with 100% cash to avoid a mortgage payment. The HECM allows you to finance part of the purchase price without a mortgage payment. This means you don’t have to buy the home outright to avoid a mortgage payment. This enables you to keep more cash in the bank to finance your retirement lifestyle.
Increased purchasing power
The HECM for purchase program allows you to buy more home than you could otherwise afford. Your purchasing power is not limited by your cash on hand or the mortgage payment you can afford.
Think about it: if you have only $200,000 to buy a home and you want to avoid a mortgage payment, you can only buy a home priced at $200,000 or less.
But what if you could finance part of the purchase price with no mortgage payment? That enables you to spend a lot more than $200,000. If your down payment is roughly half the value of the home, that means you could purchase up to a $400,000 home with your $200,000 cash and still not have a mortgage payment!
That certainly opens up some possibilities, doesn’t it?
Realtors, are you paying attention?
This is probably the most common criticism of the HECM reverse mortgage. Yes, the closing costs can be high, but it doesn’t mean they will be high. How much the closing costs are depends on the purchase price of the home, where it’s located, how much you intend to borrow, and the current interest rate landscape.
A HECM reverse mortgage typically has three types of closing costs:
- Third party costs – These are the third party services required to get your reverse mortgage done, including title, escrow, appraisal, government recording, etc.
- Origination– This is a fee paid to the lender to do your reverse mortgage. You may be able to negotiate this with your lender.
- IMIP – This fee is paid to FHA and is what makes it possible to never make a mortgage payment. This is also what makes the HECM non-recourse.
If you would like to get a rough estimate of closing costs, check out our reverse mortgage purchase calculator.
If you would like a more exact estimate, consult with a reputable HECM lender.
Reduced home equity in the future
I don’t consider this a “con” per se, because it’s how the HECM is supposed to work. The program is designed to convert equity into cash. In this case, it does it indirectly by using home equity to pay for mortgage interest so you don’t have to make a mortgage payment every month.
However, it’s important to realize that you likely will have less equity in the home in the future if you have a reverse mortgage. This doesn’t mean you’ll run out of equity any time soon, but you’ll have less equity than if you didn’t have a reverse mortgage. The reverse mortgage may not be a good fit if you foresee needing that equity in the future.
It’s a good bet you’ll have a lot of equity in the home for years to come. The program has to work that way or it can’t remain financially viable.
Remember, the HECM reverse mortgage is a non-recourse loan, which means FHA will cover the shortage if the home isn’t worth enough to pay the entire loan balance. If the HECM used up equity quickly, then FHA will be paying off a lot of shortages, which means the HECM program doesn’t work. It has to preserve equity at the same time it gives you access to equity.
A great home purchase program
Hopefully these reverse mortgage for purchase pros and cons have helped clear up whether a HECM purchase loan could be right for you. Like any financial tool, whether or not it’s a good fit depends on your goals and situation. If financing a home purchase without a mortgage payment is a possible game-changer for you, then the HECM could be a great fit.