One of the important ways in which reverse mortgages differ from forward mortgages is the difference in the urgency to proceed. A prospective home buyer who needs a mortgage to make the purchase is under the gun to have the mortgage approved and fully processed before the sale date. In contrast, senior homeowners contemplating a reverse mortgage have no deadline to meet and can be as deliberate and careful as they want. Having the opportunity to consider all options without feeling pressured is a good thing. But it can be a bad thing if the conditions that affect the terms of the reverse mortgage for which they qualify change in an unfavorable way while they are waiting.
The purpose of
this article is to indicate the kinds of changes that can
affect the reverse mortgage available to prospective
borrowers who wait for a while before making the plunge. A
rational decision to proceed or to wait should be based on a
clear understanding of these factors.
My test case
is a homeowner of 62, the minimum age for reverse mortgage
eligibility, with a home worth $200,000 and no existing
mortgage. On July 4, 2016, she could have obtained a credit
line of $99,420, a monthly payment of $551 for as long as
she lives in the house, or a payment of $1098 for 10 years.
If she waits for, say, three years, three things will
change.
She Will Grow Older
We know this
with complete certainty. We also know that if everything
else stays the same, her credit line and monthly payment
draws will be larger. For example, her credit line will
increase to $103,020, or by 3.6%. If her existing needs are
not pressing, that supports a decision to wait.
Her House May Appreciate
Most houses
appreciate in value most of the time, but not all the time.
In modelling the HECM reverse mortgage market, HUD assumes
that home prices on balance will appreciate by 4% a year.
Using that assumption over a 3-year wait, the senior’s
credit line will grow to $116,312, or by 17%. This reflects
the combined effect of the borrower being three years older
and her property appreciating by 4% a year over 3 years.
Monthly payment increases would be similar. Although she
cannot be as certain that her house will appreciate as she
is that she will be older, in most cases the prospect of
appreciation strengthens a decision to wait before taking
out a reverse mortgage.
My surmise is
that many seniors with a latent interest in reverse
mortgages intuitively understand that delaying a decision
while they grow older and their house appreciates will work
to their advantage. What they are less likely to understand
is that a rise in interest rates can easily torpedo their
plans, while there is no possibility that a decline in rates
will benefit them.
Interest Rate Changes Are the
Potential Spoiler
To summarize,
a starting credit line of $99, 420 for a senior of 62 with a
$200,000 house would increase to $116,312 by waiting 3
years, during which period the house appreciated by 4% a
year. These credit lines were based on an adjustable rate
mortgage with a start rate of 5%, which I assumed was
unchanged over the three years. We now need to consider the
implications of a change in market rates.
They are grim.
Interest rate increases will have a large negative impact.
If the rate goes from 5% to 6%, the credit line will drop to
$94,715 or by 18.6%, wiping out the favorable impact of the
borrower’s greater age and property appreciation. If the
rate goes to 7%, the decline will be 36.8%. If the rate goes
to 8%, it will be 51.4%. These are not unusual rates. I have
had two mortgages in my life, one at 6%, the other at 8%,
and I lived through an episode where rates hit 17%.
In today’s
market, furthermore, the exposure of potential reverse
mortgage borrowers to interest rates is completely
asymmetrical. A decline in rates below 5% will have zero
impact on the draw amounts available to borrowers. As the
insurer of all HECM reverse mortgages, HUD determines draw
amounts and it has set maximums at a rate of 5%. Future
reverse mortgage borrowers will not benefit from a drop in
rates, but they will lose big from an increase.
Bottom Line
The benefit of
delaying a reverse mortgage transaction is a small increase
in draw amounts if interest rates stay the same or decline,
while the risk is that even modest increases in rates will
reduce draw amounts substantially. It might be prudent for
seniors on the fence regarding whether they want a reverse
mortgage or not to engage in watchful waiting. But for those
who realize that a reverse mortgage will substantially
enhance their lifestyle, watchful waiting is procrastination
that could cost them dearly.
