3 minute read
Most homeowners who obtain a reverse mortgage do it for one primary reason: to eliminate the required monthly principal and interest mortgage payment. And that makes perfect sense.
For retirees living on a fixed income, removing a large monthly obligation can dramatically improve cash flow, reduce stress and create more flexibility during retirement. In fact, that payment elimination feature is one of the biggest reasons the federally insured Home Equity Conversion Mortgage (HECM) has become such a powerful retirement planning tool.
But here’s what many homeowners never realize: The most common reverse mortgage product, the adjustable-rate HECM, has multiple advantages when making payments. Not required payments, but VOLUNTARY payments.
The hidden flexibility of the HECM
Most people assume a reverse mortgage works like a one-way street: once the loan balance starts growing, there’s no turning back. But that’s not true.
With an adjustable-rate HECM, borrowers can make what are known as “partial prepayments” at any time without penalty. And if those payments are made consistently, using the same interest rate, over the same time period, the reverse mortgage will amortize very similarly to a traditional forward mortgage. In other words, the loan balance would shrink instead of grow.
But unlike a traditional mortgage, the HECM offers two enormous advantages that many homeowners and even financial professionals overlook.
1. Every payment increases liquidity
This is where the HECM becomes truly unique. When borrowers make payments toward an adjustable-rate HECM, three things generally happen simultaneously:
- The loan balance decreases
- Home equity increases
- The available line of credit increases dollar-for-dollar
That last point is critical. With a traditional mortgage, payments simply reduce debt. The money is gone. There is no future access to it unless the homeowner refinances or applies for a new loan.
With the adjustable-rate HECM, voluntary prepayments restore borrowing capacity. That means liquidity increases every time a payment is made. And for retirees, liquidity matters. Emergencies happen. Healthcare costs rise. Investment markets fluctuate. Having access to available funds later in retirement can be incredibly valuable.
Unlike many traditional home equity lines, the HECM line of credit cannot be frozen or reduced because of declining home values, as long as borrower obligations are met.
2. Payments are optional
With a traditional mortgage, stopping payments creates immediate risk. Miss enough payments and the home will be lost to foreclosure.
With a HECM, voluntary payments remain exactly that: voluntary. There is no required monthly principal and interest payment schedule forcing the borrower into a rigid obligation. That flexibility can be life-changing during retirement because income and expenses rarely move in straight lines.
A different way to think about home equity
This doesn’t mean every borrower should make monthly payments on a reverse mortgage. In many cases, eliminating the payment entirely is the right decision.
However, sophisticated homeowners and financial planners are increasingly recognizing something important: The adjustable-rate HECM is not just a “last resort” loan. Rather, it is a flexible financial planning tool.
Some homeowners will “pool” or “stack” voluntary payments into one calendar year when the borrower wishes to itemize deductions. Others will take their required minimum distribution (RMD) and make a large windfall payment to create an offsetting 1098 deduction.
When used strategically, it can provide both payment relief today and liquidity growth for tomorrow, a combination that traditional mortgages simply cannot match.
Dan Hultquist is the Co-Founder of REVERSE plus.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners. To contact the editor responsible for this piece: [email protected].
I do not oppose the concept presented but I do question the use of “the same interest rate” which creates the illusion of a fixed rate HECM when the note interest rate is variable with a cap of 5% or 10% of the initial note interest rate at the selection of the borrower (but at times is done impermissibly through some “sage” decision of the HECM originator). Is there any need to expand on the forgotten option of the annual AR HECM which was once the rage of the industry?
One fundamental issue with using the same interest rate is what should that interest rate be? To date, no statistically valid study has been conducted demonstrating that the adjustable rate (AR) HECM’s expected rate results in a reasonable estimate of what the actual average effective note interest rate turns out to be. This study should have been conducted years ago and been updated as the majority of the AR HECM note index interest rates switched between one month and one year CMTs to LIBOR indices (now to even to the SOFR index) and back to the CMTs again.
Most in our industry find whatever HUD says can be used in our AR HECM loan documents is perfectly acceptable for mortgage and financial planning purposes. Yet HECM originators, financial advisers, prospects, and borrowers should be demanding more of our industry.
As to “pooling” or “stacking” (whatever such lingo may mean), reverse mortgages, particularly AR HECMs and negatively amortizing forward mortgages can enhance and even create opportunities to lower income tax liabilities through the long time tax strategy known by US tax practitioners as the bunching of itemized deductions. Yet the deduction of reverse mortgage interest are limited by the use of the related loan proceeds and income tax elections made by borrowers.
Yet there are many other benefits from the pay down of reverse mortgage balances which are beyond the scope of a mere comment. I look forward to Dan addressing them in future articles.