Reverse Mortgage, HECM, Expected Interest Rate, Accrual Rate, Credit Line

Should I Take Out a HECM Reverse Mortgage Now, or Wait?
March 18, 2013, Revised April 25, 2013

Do you own a house, are you 62 or older, and are you worried about running out of money down the road? If your answer is “yes” to all three questions, you should take out a HECM reverse mortgage ASAP.  

Some financial planners advise seniors to delay taking out a reverse mortgage if they don’t need the money now. Their argument is that by waiting the amount they will be able to draw increases, reflecting their shorter remaining life span and appreciation in the value of their property. 

This advice is plausible for seniors who would be tempted  to use up most of their borrowing power shortly after they took out the HECM, but it is poor advice for those prepared to wait it out. This article explains why.

Basic Features of HECMs

The Federal HECM reverse mortgage program allows seniors of 62 or older who own and occupy their homes to take out a mortgage against it. What makes it a “reverse mortgage” is that the amount owed tends to rise over time, whereas on a standard mortgage it tends to decline.  

This difference arises from another one, which is that no payment is required on a HECM until the senior sells the house, moves out of it permanently, or dies. On standard mortgages, as every borrower knows all too well, they must begin making payments immediately.   

Another important difference between HECMs and standard mortgages is the role of interest rates. A feature unique to HECMs is that every transaction involves two interest rates.  

Expected interest Rates

The expected rate on a HECM is used to calculate the amount the senior can draw under the different options. Seniors can draw cash, take a credit line, or receive monthly payments for life or for a specified term. The higher is the expected rate, the smaller is the amount obtainable under any of these options. Part of the reason it does not pay to delay taking out a HECM is that expected rates are very likely to rise in future years, which will reduce the size of future HECM draws. 

Accrual Rates 

The accrual rate on a HECM is the rate used to calculate the interest due the investor every month, exactly the same as on a standard mortgage. The only difference is that on a standard mortgage the borrower must pay the interest due every month whereas on a HECM the interest is added to the loan balance.   

The accrual rate on a HECM can be fixed or adjustable, but the fixed rate is available only on transactions in which the borrower draws the maximum amount allowable in cash. Borrowers who want a credit line or a monthly payment plan must accept an adjustable rate.  

Some seniors have been frightened away from adjustable rate HECMs because they have heard horror stories about borrowers who were bludgeoned by rising rates. But rising rates endanger borrowers only when they result in rising required payments, as they do on standard adjustable rate mortgages. There is no required payment on HECMS.  

Furthermore, rising rates on HECMs benefit borrowers with unused credit lines, which grow at the same rate as debt. This is a second part of the reason it does not pay to delay taking out a HECM. While rising expected interest rates in the future reduce the size of the draws available to those who wait to take a HECM, rising accrual rates increase the growth rate of the credit lines that are taken out now.

Proof of  the Pudding 

I have done extensive modeling to compare unused credit lines, debt and equity on a standard adjustable rate HECM in 10 years if a) the borrower takes one now at age 62 and does not draw any funds during the 10 years, or b) waits until she is 72 to take the HECM. See the table at the bottom.  

If this comparison is done on the assumption that current interest rates continue for 10 years, then it pays to wait. For example, if the borrower has a property worth $200,000 today, her maximum credit line is $115,059 which if unused will grow to $162,430 in 10 years at current interest rates. If she waits 10 years to take out the HECM, her line will be $189,283 because she will be 10 years older and her property will be worth more.  

However, if the accrual rate plus mortgage insurance premium average 8% over the 10 years rather than the 3.453% rate today, the unused line will grow to $255,390, or well in excess of the $189,283 line she could draw by waiting. And if the expected rate in 2023 is 10% instead of 4.12%, the line available by waiting until 2023 to take the HECM would be only $82,410.  

Of course, we can’t predict the future with any degree of certainty, but in my view, the odds strongly favor taking the HECM now. This partly reflects a judgment that interest rates are bound to rise over the next 10 years. Further, the magnitudes involved are also compelling. On a stable rate assumption the benefit of waiting is $26,853 while on the rising rate assumption, the benefit of taking the HECM now is $172,980.  

Concluding Comment 

There is one important proviso to the argument that it pays to take out a HECM as soon as possible. The argument applies only to those who leave their credit line largely unused. If you draw more than half of it out right away, rising rates will expand your debt faster than it will expand your unused credit line. Compulsive spenders might well do better by waiting.  

 

                                           HECM on House Worth $200,000 in 2013:

                                   Status in 2023 if HECM Is Taken Now Versus 2023 

 

2013

Status in 2023

Credit Line at 4.12% Expected Rate

Initial Amount Owed

Unused Credit Line

Amount Owed

Property Value at 4% Growth Rate

Equity

Take HECM Now, Stable Rates

$115,059

$8,741

$162.430 at 3.453%*

$12,340 at 3.453%*

$296,049

$283,709

Take HECM Now, Rising Rates

$115,059

$8,741

$255,390 at 8%**

$19,402 at 8%**

$296,049

$276,647

Take HECM in 2023, Stable Rates

 

 

$189,283 at 4.12%

$11,142

$296,049

$284,907

Take HECM in 2023, Rising Rates

 

 

$82,410 at 10%***

$11,142

$296,049

$284,907

 *Current value of ARM accrual rate plus 1.25% mortgage insurance premium

**Assumed average ARM accrual rate plus 1.25% mortgage insurance premium over 10 years

***Assumed expected rate in 10 years


 

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