| October 4, 2004, Revised
October 25, 2006, November 16, 2007 "My
wife and I are 68 years old and can qualify for a reverse mortgage on our
current house, but we want to relocate first. Can we buy a new house with a
"forward" mortgage, and then take out a reverse mortgage?"
There are three ways to acquire a
new house while taking out a reverse mortgage. One way is to buy the new house
with
a mortgage small enough that it can be paid off
with the proceeds of the reverse mortgage. The second way is to pay all-cash for
the house, then reverse mortgage it as before. The third way is to purchase the
house and take out the reverse mortgage in one transaction. These will be
considered in turn.
Buy With a Mortgage, Repay With a Reverse
Mortgage
If you take out a forward mortgage to
purchase a house, you must repay it when you take out a reverse mortgage. You do that by drawing a
lump sum under your reverse mortgage equal to the balance of the forward
mortgage. The balance must be smaller than the amount you can draw under a
reverse mortgage.
For example, suppose you pay $200,000 for
your new house. A married couple both of whom are 68, on October 25, 2006, could draw a lump sum under a
Home Equity Conversion Mortgage (HECM, which is the FHA reverse mortgage),
secured by that house, of about $104,000. It varies a bit over time and from one county to
another. If you took out a forward mortgage of $160,000 to buy the house, you
would not be able to pay it off with the HECM and therefore would be ineligible.
If you took out a forward mortgage of $100,000, you would be able to pay it off
by drawing on the HECM, but there would be only about $4,000 left for other purposes.
That doesn't mean you shouldn't do it.
Eliminating the forward mortgage eliminates the monthly payment on that
mortgage, which frees up your income for other purposes. Further, the unused
part of the line ($4,000 in my example) will grow by 4-5% a year, depending on
future interest rates, so you will have more to draw on in the future if you
don't use it up now.
Obviously your game plan won’t work unless
the down payment on your next house is 50% or more. You can draw only $104,000
on a $200,000 house because at 68 you are still expected to live a long time and the reverse mortgage
lender is going to have to wait a long time before he gets his money back. If
you were both 76, you could draw over $120,000, and would only need to put 40%
down. And if you were both 86, you could draw over $140,000 and would only need
to put 30% down.
Features You Want
in the Forward Mortgage
If you purchase the home with a forward mortgage,
you want one that costs as little as possible over the short period you will
have it. It matters little whether the interest rate is
adjustable or fixed, or whether the term is 15-years or 30. What matters most is the upfront mortgage costs,
which you want to minimize.
Upfront costs consist of points, which are a
lender charge expressed as a percent of the loan; lender fees expressed in
dollars covering different services, but only the total amount matters; and
mortgage broker fees, which can be expressed in percent, in dollars or both. The
trick to avoiding all these costs is to pay an interest rate high enough that
the lender will pay you points, called a "rebate." The best instrument for this
purpose is a 30-year fixed-rate mortgage (FRM) because they carry the largest
rebates.
For example, a lender offering a 30-year FRM
at 6% and zero points might quote 2.75 points at 5.5%, and rebates of 2.125
points at 6.5% or 3 points at 6.75%. You want a rebate large enough to cover the
other lender fees plus the mortgage broker’s fee. If the rebate is larger than
needed for that purpose, however, it won’t go to waste; the excess can be
applied to third party charges, such as title insurance.
Also, you must make absolutely sure that your
loan does not carry a prepayment penalty. Pay careful attention to the Truth in
Lending disclosure statement that you receive. Near the bottom, it will say that
if you pay off your loan early, you either may, or will not, have
to pay a penalty. If it is marked may, it means you will have to
pay a penalty. See
Disclosure Rules on Prepayment Penalties.
Note: Lenders do not like making
loans carrying large rebates that are paid off very quickly, and if
such a loan comes through a mortgage broker, they may well require
the broker to pay back the rebate. It would be best, therefore, to
obtain such a loan from a lender rather than a broker.
Buy With
All-Cash, Then Do a Reverse Mortgage
You can avoid all costs on a forward mortgage
by not taking one -- by paying all cash for your new house. Since you must put 50% down anyway, you
should consider putting 100% down. If you
have the cash sitting in low-yield investments, that would be a prudent move.
You would then have access to your entire HECM credit line, which could be drawn
on to replace some of the assets you liquidated to purchase the house, or for
any other purpose.
Buy the House
With a Home Keeper Reverse Mortgage
Another way to avoid the cost of
a forward mortgage is to use Fannie Mae's Home Keeper reverse mortgage, which
has the unique feature that it can be used in a purchase transaction. However,
Home Keeper offers such low lump sum draws, relative to HECM, that it is not a
viable option. For example, where you could draw $104,000 on the HECM, on Home
Keeper you could draw only $29,000.
In sum, if you have the liquid
assets, the cheapest way to purchase a house and reverse mortgage it is to pay
all-cash for the house, then (if desired) replenish part of the assets used by
drawing on an HECM. Next best is to purchase with a forward mortgage having
minimal upfront costs, then repay it with a lump sum draw on a HECM. Third best
is to purchase the house with Fannie Mae's Home Keeper, which avoids the cost of
a forward mortgage but offers much lower draws than the HECM.
Copyright Jack Guttentag 2007
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