Waiting Can Pay Off On a Reverse Mortgage
Larry Kaplan didn’t wait long before getting a reverse mortgage on his Los Angeles home. Kaplan, 63, obtained a
reverse mortgage one year after the minimum age of 62 when homeowners can use their home as collateral in a reverse mortgage loan.
Kaplan says he didn’t want to wait any longer because as someone who was forced by the Great Recession six years ago to work for himself as a home-based consultant for nonprofits, he didn’t earn “enough to make me feel fully confident that I could continue to meet my monthly expenses as I get older.”
For now he’s using a reverse mortgage as a line of credit. Kaplan lowered his monthly cash flow requirements by 25 percent by ending the monthly mortgage payment through a reverse mortgage, and says he plans to use it primarily as a “rainy day fund that I will tap into only when absolutely needed.”
Waiting well beyond age 62 to get a reverse mortgage also has its benefits. If a home’s value is likely to appreciate, waiting can lead to more equity to tap. But if interest rates also rise and home prices drop, the amount available to borrow could be reduced.
Reverse mortgage primer
A reverse mortgage eliminates monthly mortgage payments, allowing the borrower to continue living in the home until they die or move — when the loan and interest is repaid. Any money that the home is sold for beyond the loan amount goes to the borrower or their heirs.
Homeowners must have substantial home equity to get a reverse mortgage. Payments from the loan can be in a lump sum, a monthly amount, or borrowers can use the reverse mortgage as a lending limit (also called a line of credit) to use when they need it, as Kaplan is doing. The credit line rises over time with the interest rate.
If the home is paid off, 50-60 percent of the home’s value can be used in a reverse mortgage, says Justin Chidester, an accredited financial counselor in Logan, Utah, who counsels senior homeowners on reverse mortgages.
The most common reverse mortgage is the government-insured Home Equity Conversion Mortgages, or HECM. The Federal Housing Administration backs loans for up to $625,500, providing insurance against the risk that the contracted payments aren’t made and against the loan balance exceeding the property value when sold.
In an example calculated with loan estimate software by Chidester, the financial counselor, a 68-year-old might get a quote for a reverse mortgage that offers them more money than if they got it at age 65 — if the home’s value rises.
On a $500,000 house the 65-year-old might get a $271,000 loan in a lump sum. Waiting three years could get them $298,000 — $27,000 more — if the home appreciated 2 percent to $530,000, Chidester says.
That extra $27,000 might not sound like much, but it could be the difference between affording an emergency expense and not being able to. It depends on what you need the money for and when. If you can afford to wait, it can be worthwhile, Chidester says.
“You’re always going to be able to get more if you take it out later — always,” he says, whether it’s a lump sum or monthly payment.
It can also be smart to wait if you’re confident your home will appreciate in value by a large amount, Chidester says, or if you’re expecting a windfall that you can use to reduce your mortgage before you get the HECM.
Credit limit grows
While a lump sum payment from a reverse mortgage is all of the money a borrower will be getting and is a fixed rate loan, a credit limit that is only used when needed increases the amount that can be borrowed. As a line of credit, however, the interest rate on the loan is adjustable.
“The credit limit is not stagnant,” Chidester says. “It’s actually a line of credit that grows over time.”
The loan limit is based on the home value, age and expected interest rate. The home appreciation rate is directly correlated to the rate that the principal limit increases. For example, if your home appreciates 3 percent in one year, you’ll get a 3 percent higher loan limit. It also increases a little more because you’re one year older.
A monthly payment is also very flexible, he says. It’s calculated as if you’ll live to be 100, spreading the payments evenly until age 100.
Recent changes to federal rules for reverse mortgages have made lump sum payments more costly.
A lump sum has fees that are five times as high as they are for a monthly payment. Mortgage insurance premiums are higher if more than 60 percent of the total amount available in the first year is taken out — rising from 0.5 percent for withdrawing less than 60 percent, to 2.5 percent of the appraised value for taking out more.
Using a loan limit or credit limit allows the loan limit and loan balance to grow independently of the home’s value or how much equity you have in the home, Chidester says.
The limit and the balance could exceed the home value over time, giving a borrower who lives to an old age more money than their home is worth.
In the example Chidester gave for the 65-year-old with a $500,000 home, the monthly payment in a reverse mortgage for a $271,000 loan limit would be $1,517. If the credit limit didn’t grow over time, that monthly amount would drop to $645.
If they waited three years, they could get a monthly payment of $1,618. If their home appreciated 2 percent for those three years, it would rise to $1,720.
5% interest rates worrisome
As the Federal Reserve Board considers raising lending rates, adjustable rate mortgages and interest rates charged to borrowers in reverse mortgages could rise.
For now, most reverse mortgage interest rates are at 4 percent. HECM regulations are changing almost constantly, Chidester says, and as long as the expected rate stay below 5 percent, the loan amount that borrowers qualify for won’t change. That’s because the minimum HECM expected rate used to calculate the principal limit is a 5 percent floor, he says.
Usually large-scale changes to HECM will come with advance notice, Chidester says, giving reverse mortgage borrowers time to apply before they rise.
“Even if interest rates go up, it’s actually going to increase the amount you can get out of a reverse mortgage,” he says.
A financial planning tool
For Kaplan, the Los Angeles homeowner who took out a reverse mortgage at age 63, improving his cash flow by not having a mortgage was his principal objective and increasing the equity was secondary.
He says he considered refinancing his home loan to a lower interest rate, but an uneven income as a consultant would have made it difficult to get a loan.
Kaplan did considerable research and consulted with his accountant, financial advisor and a mortgage broker who wasn’t the same broker doing his reverse mortgage. It turned out to be a good move for him, he says.
“My assessment is that reverse mortgages are good tools for financial planning in retirement or for those nearing retirement, but frankly only one you should do if you need to,” Kaplan says.
“If you can afford to continue paying your existing mortgage and have access to liquid assets from other sources, you should probably not obtain one,” he says.