Using a HECM Reverse
Mortgage to Insure
Against Running Out of Money
December 17, 2012
“Is there a way for seniors
living off of retirement
assets to insure themselves against running out of
money?”
The
traditional way is to purchase a lifetime annuity, which
involves giving your assets to an insurance company in
return for the company’s promise to pay you a certain return
for as long as you live. Today, an alternative that keeps
your assets in your own hands is available to any senior
with significant equity in the home they occupy as their
principal residence. The alternative is the HECM reverse
mortgage administered by FHA.
The Risk of Running Out of Money
Millions of seniors retire with a modest nest egg that they
intend to use up during their retirement years, but face the
risk that their funds will be fully depleted while they are
still alive. They may follow the advice of a financial
planner who tells them how much of their fund they can draw
each year consistent with a low probability of running out
of money. However, a low probability of going broke can be a
source of continued anxiety.
A
standard remedy for anxiety associated with low-probability
hazards to life, limb or pocketbook is insurance. In this
case, the insurance is provided by the Federal Government
with the HECM reverse mortgage program. But the senior must
use the program properly.
Using a HECM as an Insurance Policy
A HECM
can be used to insure against running out of money by
electing a credit line for the maximum amount available,
which will depend on the senior’s age
and the value of her home. The actual amount borrowed
at the outset is just large enough to cover the upfront
charges. Her credit line grows at a rate equal to the
interest rate on her HECM, which changes every month, plus
the 1.25% insurance premium.
Consider a senior with a house worth $400,000 who retires
now at 62 and plans to draw down his nest egg over 20 years.
If he takes a standard adjustable rate HECM at the rate on
November 14, 2012 of 2.459%, he receives an initial credit
line of $230,359, which untouched grows to $483,000 over 20
years if the interest rate stays the same. But at an
interest rate of 8%, his credit line at age 82 would be $1.5
million, and at the maximum rate of 12.459% (10 percentage
points above the start rate), it would be $3.6 million.
While many borrowers fear adjustable rate mortgages because rising rates increase the mortgage payment, that is only true on standard mortgages. On a HECM there is no required payment and rising rates increase the growth of an unused credit line. Seniors using the HECM to insure against the possibility that their financial assets will run out benefit from rising interest rates.
Cost of HECM Insurance
The cost of this policy to the senior is the upfront fees which are financed, and which also grow over time. The fees in the example amount to about $17,000 when the HECM is taken out, growing to about $36,000 20 years later at the current interest rate.
There Has Never Been a Better Time to Take a HECM
Given
the borrower’s age and property value, the amount that can
be drawn on a HECM depends on the interest rate and the
property appreciation rate: the lower the interest rate and
the higher the appreciation rate, the larger the draw. HUD
assumes a property appreciation rate of 4%, which has been
the average over many decades, and does not adjust for
changes in the economy. The interest rate used, however,
termed the “effective rate”, is a market rate that adjusts
every week and is now below the floor of 5% set by HUD. It
can go no lower, but it can go higher, and it will in time.
The
bottom line is that initial credit line draws are now at
their peak, and the rate of increase in credit lines taken
now will accelerate when interest rates start to rise. The
time to take a HECM is now.
Intra-Family Tension Over Loss of Equity:
Reverse
mortgages result in loss of equity in the home, which can be
a source of tension between the seniors involved and their
heirs, who are usually their children. Using the HECM as an
insurance policy, however, uses only a small part of the
equity unless the worst happens -- they run out of money and
must draw on their credit line. Explaining to the kids that
they will only use the line if they have to should go a long
way toward melting their resistance.
