Why a Reverse Mortgage Leaves Money Behind

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Why Does a HECM Leave Money Behind?

December 1, 2003

“I was my aunt’s only relative, and when she died I was surprised to inherit a house worth $250,000, with reverse mortgage debt of only $90,000. I had encouraged her to exhaust the equity in her house, and she always told me that she was using it as fast as the program would allow. Could that have been true?”

It is possible. It is also possible she was stringing you along because she wanted to leave you something. You will never know.

FHA’s Home Equity Conversion Mortgage (HECM) is an excellent product for elderly homeowners who need additional cash. HECM allows the owner to draw on a line of credit, receive a monthly payment for as long as she remains in the house, or receive a payment for a specified term. The debt need not be repaid until the owner dies, sells the house, or moves out permanently.

A weakness of the HECM, however, is that it is extremely difficult to use up all or even most of your equity – house value less mortgage debt. This is great for heirs, but not so great for seniors who want to get as much money as possible out of their house, and don’t care about leaving anything to their heirs.

The amount of equity a homeowner with a HECM leaves in her estate depends in part on how long she is in the house after the contract is closed. The earlier it is terminated, the smaller the debt and therefore the greater the equity. The owner may have little control over this.

A second factor, which the owner does have control over, is the payment option selected. Assuming the contract terminates before the owner reaches age 100, she will leave the least equity to her estate if she takes a credit line and uses it up in a short period, e.g., 2 years. If she converts the line into a monthly payment for a term longer than 2 years, she will leave more equity. If she takes a tenure payment that continues for as long as she lives in the house, she will leave the most equity. However, if she stays in the house until age 100, the equity will be the same for all the options.

A third factor is the appreciation in the value of the property after the HECM is taken out. Such appreciation affects the size of the estate but not the amounts that the owner can draw under that contract.

The fourth factor is whether the value of the property at the time the HECM was taken out was higher than the FHA loan limit. If it was, the credit line was based on the loan limit, and the excess value lands in the estate as additional equity. However, this excess value along with subsequent appreciation could make it worthwhile to refinance the HECM, as indicated in Can a HECM Be Refinanced?