The Mortgage Professor: Is an HECM 'reverse mortgage' a good choice?



The Mortgage Professor

In a recent article, I described a reliable and easy-to-use calculator that could improve the ability of seniors to determine whether their lives would be improved by an HECM, or reverse mortgage. However, having a tool is one thing; knowing how to use it effectively is another.

This article illustrates how the HECM calculator can be used to determine whether a reverse mortgage would work for each of three seniors who have very different needs. Senior Long anticipates possible needs well into the future, senior Short has pressing needs right now, and senior Medium, who is more typical, has both present and future needs.

There are three ways to draw funds on a home-equity conversion mortgage, or HECM: as upfront cash, as a monthly payment, or as an unused credit line. Through a process of trial and error with the HECM calculator, the senior finds the option or combination of options that best meets her needs. She then compares the funds she can draw with the total settlement costs and decides whether the benefits are worth the cost. Lurking in the background is loss of equity in the home, which may or may not be relevant to any senior.

Senior Long is 79, has a house worth $400,000 with no mortgage balance, and has no immediate need for additional funds. But Long is concerned that the nest egg from which she draws her living expenses will become depleted while she is still alive -- she will outlive her money. She wants protection against that contingency.

The HECM calculator indicates that on Feb. 20, 2014, Long could obtain a credit line of $233,000 on an adjustable-rate HECM. If left untouched, the credit line will grow every year at a rate equal to the current interest rate, plus the mortgage insurance premium. If her nest egg becomes fully depleted while she is still alive, she can begin drawing on her unused line of credit. As an illustration, if the interest rates on Feb. 20 continue unchanged, the unused line will be $848,000 when she hits 95. If rates increase in the future, the available line will be larger.

The ratio of available funds to financed settlement costs of $8,200 exceeds 28 to 1. I view this as an easy decision, because even if Long wants to leave as large an estate as possible, the HECM will absorb very little of the equity in her house unless she outlives her assets.

Senior Short is 65, his house is worth $200,000 with a $98,000 mortgage balance, and because his income has declined, he is having difficulty making the mortgage payments. The HECM calculator shows that a fixed-rate HECM will allow him to pay off his existing mortgage, eliminating the payment burden, but with nothing left for future draws -- Short will max out at age 65. Further, the ratio of available funds to upfront settlement charges is only about 10, which makes it a costly transaction.

This is a much tougher call. My advice to Short would be to explore whether there is a way he could continue making payments on his existing mortgage for five more years. The HECM available to him at that point, in addition to paying off his remaining mortgage balance, could put money in his pocket or his future, which a HECM today will not do. But if no such option exists, taking the HECM now is arguably better than eating dog food or losing the house to foreclosure.

Senior Middle is 75 with a house worth $400,000 and an existing mortgage balance of $80,000. The HECM calculator indicates that on Feb. 17, 2014, she could have paid off the $80,000 balance and had a credit line of $153,380 on an adjustable-rate HECM. Middle would like to reserve only about $40,000 for future use, but wants $10,000 in cash now to pay off some other debts, and would like as large a monthly payment as possible for as long as she is in the house.

When she enters $1,000 as a desired monthly payment, the calculator indicates that her maximum is $898, and this would leave nothing in her credit line. So she tries $600, which works because it leaves a credit line of $46,000.

The bottom line for Middle is that she can draw $10,000 in cash, $600 a month for as long as she lives in the house, and have a $46,000 credit line in reserve that will grow every month that it is not used. The present value of the funds she can draw is 27 times larger than the settlement costs of $8,200.

This is an easy decision if Middle has no interest in the size of her estate. Because the transaction depletes much and possibly all of the equity in her house, however, the decision becomes more difficult if she has such a concern. Middle, and the many other seniors in a similar situation, must answer this question for themselves. The best the calculator can do is tell them what the question is.

Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at

Last modified: April 17, 2014
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