Can You Buy a House, Then "Reverse Mortgage" It?
October 4, 2004, Revised October 25, 2006, November 16, 2007, December
2, 2008
"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.
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 maximum 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 December 2, 2008, could draw a lump sum under a Home Equity Conversion Mortgage (HECM, which is the FHA reverse mortgage), secured by that house, of about $120,000. 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 $20,000 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 ($20,000 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.
You can draw only $120,000 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 almost $140,000, and would only need to put 30% down. And if you were both 86, you could draw almost $160,000 and would only need to put 20% down.
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.
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.
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 may not be a viable option. For example, where you could draw $120,000 on the HECM, on Home Keeper you could draw only $31,000.
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.
"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 maximum 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 December 2, 2008, could draw a lump sum under a Home Equity Conversion Mortgage (HECM, which is the FHA reverse mortgage), secured by that house, of about $120,000. 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 $20,000 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 ($20,000 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.
You can draw only $120,000 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 almost $140,000, and would only need to put 30% down. And if you were both 86, you could draw almost $160,000 and would only need to put 20% 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 may not be a viable option. For example, where you could draw $120,000 on the HECM, on Home Keeper you could draw only $31,000.
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.