The FHA Home Equity Conversion Mortgage (HECM) is by far the most popular reverse mortgage program because it comes with a strong federal guarantee and a variety of payment options for borrowers to choose from throughout the life of the loan.
The single biggest drawback however is the difficulty to understand it. Which can be even more challenging for consumers who are of a ripe age. You will see why this is so as you read on.
Applicants to the program can choose from the following payment options:
- Term
- Tenure
- Line of credit
- Modified term
- Modified tenure
A term option refers to the borrower receiving a fixed monthly amount as payment until a future specific period in time which the borrower decides on.
A term option refers to the borrower receiving a fixed monthly amount as payment for as long a period as the borrower remain as a permanent resident of the house.
Choosing the line of credit gives the borrower a credit line with a withdrawal limit which he/she can draw upon at any time of his/her choosing. This will also be the option should a borrower desire to draw a maximum lump sum of money at one time.
A modified term refers to a combination of the term option and line of credit.
A modified tenure refers to a combination of the tenure option and a line of credit.
The modified options will undoubtedly result in a lower withdrawal limit compared to a straight out line of credit option.
The diverse selection of payment options are meant to serve the different individual needs of each senior borrower.
This is one reason why the HECM program proved to be such a huge success.
Principal limit
The principal limit refers to the maximum amount that a borrower can draw from the facility.
This limit is determined by 3 main factors:
- Property value
- Age of borrower
- Interest rate
Lenders will undoubtedly approve a limit that is within a comfort zone of the property’s value. This helps minimize the risk that they would lose money of such a deal.
The age of borrower is another primary concern as it directly impacts the length of time a lender will have to commit to the facility without receiving any payments back from the borrower.
The interest rate measures the cost of credit which is always a cause for concern to any lender.
The principal limit however, has a limit by itself.
When a property’s value exceeds the FHA’s relevant loan limit, FHA’s limit will be used.
For example, if two reverse mortgage borrowers apply for the loan with home values of $200,000 and $500,000 respectively, if the FHA limit is $180,000, both of them will be offered the same limit of $180,000 on the account.
This means that homeowners with highly valued real estate would be able to obtain a larger loan from other reverse mortgage programs available in the country.
The limit might be worth just a mental note should the borrower is just using the facility temporarily. But it have a huge negative impact if he has a highly valuable property and intends to keep the facility for the rest of his life.
As if to challenge the brain capacity of the elderly, there are limits that exists within the principal limit as well.
Within the terms of the full principal limit contains a net principal limit.
This is a limit calculated by deducting financed settlement costs and other fees from the full principal limit.
So if a borrower has a full principal limit of $100,000 approved, the maximum amount that can be withdrawn by the borrower is less than $100,000.
Confused already? There’s more.
The costs involved can include:
- Origination fee
- Insurance premium
- Monthly account servicing fee
- etc
The silver lining is that the lender will have to deliver a good faith estimate to the borrower so that the borrower will have a better idea of the charges involved with the program.
The issue with tenure payments
As mentioned previously, one of the payment options available for a borrower to choose it tenure payments.
Anyone considering this options has to take note that this option is calculated based on a borrower reaching the very senior age of 100.
This can have huge implications to the amount of equity that the borrower can eventually withdraw.
For example if a borrower is age 65 and has a net principal limit of $210,000, the monthly payment check he can expect will be $500. Should he live till the age of 80, this would mean that the total amount of money he withdrew will only be $90,000 out of that potential $210,000.
Unless the borrower has the absolute intention of leaving the remaining equity on the house to his children, he would probably be better off taking a lump sum from the onset and using that cash to buy an annuity plan from an insurer.
With that said, this is a personal choice that is dependent on the borrower’s risk profile.
To each his own.
The complication of Interest rates
HECM uses two interest rates in it’s program.
The first one has two additional adjustable interest rate options by itself.
The second, also called an expected rate is fixed for the borrower and used for lines of credit.
Choosing between these choices alone can send an average borrower into meltdown.
Refinancing
In general, refinancing a reverse mortgage will mean an increase in the amount a borrower can draw. And if they are lucky, it will come with lower interest rates as well.
This is because over time, property value will tend to appreciate, therefore increasing the principal limit.
However, it must be noted that refinancing a loan will mean a new set of closing cost to be incurred by the borrower.
Conclusion
With all that is discussed above, my opinion is that credit lines are the best option for borrowers considering reverse mortgages.
It enables the borrower to access funds up to the principal limit.
If a term or tenure option is preferred, consider that unless a borrower lacks self-discipline, he or she can still draw an amount recurringly from the line of credit as needed.
Moreover, if there’s no rush for funds, one can always delay taking up a credit line on HECM.
The longer it is delayed, the more the property will appreciate in value, resulting a higher limit.