"Ten Strategies for using a Reverse Mortgage to help fund retirement"

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dodecahedron
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"Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by dodecahedron » Wed Aug 24, 2016 1:21 pm

Dirk Cotton has posted a great piece on his Retirement Cafe blog summarizing the many ways a reverse mortgage (aka Home Equity Credit Mortgage or HECM) can be used to help fund retirement. He included a terrific list of links to articles that flesh more details of each of these ways.

After reading this, I have concluded that reverse mortgages are the "swiss-army knives" of retirement planning. Like swiss-army knives, HECMs can be quite useful in a variety of otherwise tight situations, but--if used carelessly--they can also be quite dangerous.

In particular, the author warns us that the strategy of using a HECM to enable increased equity holdings could be a quite disastrous form of leverage and he links to a new article from FINRA, Avoiding a Reversal of Fortune, laying out the dangers of such an approach.

As a former Girl Scout (mindful of the motto "Be prepared") now in my early 60s, I will definitely be researching this tool further. On another thread, mlebuf has told us that he is the in the process of applying for one now and wishes that he had been able to apply 12 years ago, when he was 62, because he thinks his available credit line would be twice its current value if he had done so.

SuzBanyan
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by SuzBanyan » Wed Aug 24, 2016 3:42 pm

Thanks for posting this link. I really like your analogy to a "Swiss-army" knife.

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whaleknives
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by whaleknives » Wed Aug 24, 2016 8:04 pm

Sorry, I still haven't seen an answer to the question: How is the annual FHA insurance premium paid?
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unclescrooge
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by unclescrooge » Thu Aug 25, 2016 2:00 pm

whaleknives wrote:Sorry, I still haven't seen an answer to the question: How is the annual FHA insurance premium paid?


Doesn't this only apply to houses with less than 20% equity?

Do you really think a home with little equity would qualify for an FHA loan?

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whaleknives
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by whaleknives » Thu Aug 25, 2016 3:47 pm

unclescrooge wrote:
whaleknives wrote:Sorry, I still haven't seen an answer to the question: How is the annual FHA insurance premium paid?

Doesn't this only apply to houses with less than 20% equity?
Do you really think a home with little equity would qualify for an FHA loan?

The Home Equity Conversion Mortgage (HECM) being discussed here (which is about the only reverse mortgage available today) is an FHA mortgage requiring an initial premium of 0.5 percent or 2.5 percent at closing, depending on your disbursements, and an annual premium of 1.25% of the outstanding mortgage balance. Even if you take only the line of credit and no initial payouts, the annual premium compounds, usually against the home equity.

A requirement for this mortgage is that the borrower "Own the property outright or paid-down a considerable amount". See the Wiki Reverse Mortgages and Self insure for LTC using Reverse Mortgage HECM?
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dodecahedron
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by dodecahedron » Thu Aug 25, 2016 4:38 pm

whaleknives wrote:The Home Equity Conversion Mortgage (HECM) being discussed here (which is about the only reverse mortgage available today) is an FHA mortgage requiring an initial premium of 0.5 percent or 2.5 percent at closing, depending on your disbursements, and an annual premium of 1.25% of the outstanding mortgage balance. Even if you take only the line of credit and no initial payouts, the annual premium compounds, usually against the home equity.
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According to Wayne Pfau and mlebuf, as well as my own reading, it is not universally true that the initial premium compounds if you take only the line of credit and no initial payouts. Some lenders will write a contract in which you agree to a higher interest rate formula in exchange for lender credits that wipe out the initial closing costs (including the FHA mortgage insurance premium.)

On the contract mlebuf believes he has applied for, he has an initial upfront cost of $125 (for the mandatory credit counseling from an independent nonprofit) and no other upfront costs at all to secure the line of credit (LOC). The untapped LOC will grow at the contractual interest rate from its initial value and, if he never draws on the LOC, he will not see any reduction in his equity when he (or his heirs) sells the home, so if he never exercises, his entire cost for the entire deal will be the $125 upfront fee.

This seems to be too good to be true (a very inexpensive put option on the property with a strike price that automatically grows over time) and may be an artifact of the way that FHA mortgage insurance is structured and the way these contracts are traded in the secondary market, but given the low cost, it seems worth investigating. It will be interesting to hear followups from mlebuf after his HECM has closed (I am confident he will read all the fine print carefully!) The HECM originator he is using operates in 46 states. Unfortunately, mine is one of the four where they are not yet operating so I am unable to even get any information out of them at this point. I'd be interested to know if anyone has found other HECM originators that offer similar deals.

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whaleknives
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by whaleknives » Thu Aug 25, 2016 4:52 pm

dodecahedron wrote:. . . According to Wayne Pfau and mlebuf, as well as my own reading, it is not universally true that the initial premium compounds if you take only the line of credit and no initial payouts. Some lenders will write a contract in which you agree to a higher interest rate formula in exchange for lender credits that wipe out the initial closing costs (including the FHA mortgage insurance premium.) . . .

It is not just an initial premium at closing, but also an annual premium. Does the lender somehow roll all future premiums into the initial closing costs? That would seem to require predicting the future - maybe they can give us market tips. :D
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by dodecahedron » Thu Aug 25, 2016 5:12 pm

whaleknives wrote:
dodecahedron wrote:. . . According to Wayne Pfau and mlebuf, as well as my own reading, it is not universally true that the initial premium compounds if you take only the line of credit and no initial payouts. Some lenders will write a contract in which you agree to a higher interest rate formula in exchange for lender credits that wipe out the initial closing costs (including the FHA mortgage insurance premium.) . . .

It is not just an initial premium at closing, but also an annual premium. Does the lender somehow roll all future premiums into the initial closing costs? That would seem to require predicting the future - maybe they can give us market tips. :D


The initial premium is a percentage of the home's appraised value*. The subsequent annual premium is a percentage of the accumulated loan balance, so those will be zero if the LOC is never tapped.

*Edited to clarify: the initial premium is actually a percentage of the initial "maximum claim amount" (MCA), which, in turn is generally a percentage of the home's appraised value (up to $625K), with the latter percentage depending on the age of the borrower.
Last edited by dodecahedron on Thu Aug 25, 2016 5:22 pm, edited 1 time in total.

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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by SuzBanyan » Thu Aug 25, 2016 5:13 pm

whaleknives wrote:
dodecahedron wrote:. . . According to Wayne Pfau and mlebuf, as well as my own reading, it is not universally true that the initial premium compounds if you take only the line of credit and no initial payouts. Some lenders will write a contract in which you agree to a higher interest rate formula in exchange for lender credits that wipe out the initial closing costs (including the FHA mortgage insurance premium.) . . .

It is not just an initial premium at closing, but also an annual premium. Does the lender somehow roll all future premiums into the initial closing costs? That would seem to require predicting the future - maybe they can give us market tips. :D


Here is what you quoted in the other thread: "You will be charged an initial mortgage insurance premium (MIP) at closing. The initial MIP will be .5 percent or 2.5 percent, depending on your disbursements. Over the life of the loan, you will be charged an annual MIP that equals 1.25% of the outstanding mortgage balance."

From this, it looks like 2 seperate MIP charges: a closing cost (either 0.5% or 2.5% of initial line of credit amount) and an annual amount of 1.25% of the then outstanding balance. The annual amount looks easy to calculate each year during the life of the mortgage without predicting the future.

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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by whaleknives » Thu Aug 25, 2016 5:41 pm

dodecahedron wrote:. . . The subsequent annual premium is a percentage of the accumulated loan balance, so those will be zero if the LOC is never tapped. . .

Here's what the Consumer Financial Protection Bureau said about annual costs in 2012:

    2.6.2 ONGOING COSTS & FEES
    Ongoing costs and fees consist of the monthly MIP (mortgage insurance premium), monthly servicing fee, and
    monthly interest.

    Monthly MIP: FHA assesses an ongoing MIP equal to 1.25 percent of the loan balance (principal drawn plus accumulated interest, MIP, and fees) per year on all loans, whether HECM Standard or HECM Saver.84 The 1.25 percent rate is an annual rate, but it is calculated and added to the loan balance on a monthly basis.85 Because of the negative-amortization feature of the loan, the MIP compounds in the same way that the interest does. Each month, borrowers are being charged MIP on a growing loan balance that includes prior interest and prior MIP.

    Servicing Fee: As with traditional mortgages, the servicing fee is embedded in the interest rate. Each month, servicers receive between 30 and 144 basis points (0.30 to 1.44 percent) before the accrued interest is credited to the secondary market investors.86 This fee is intended to cover the cost of sending the borrower account statements, disbursing loan proceeds, and ensuring that borrowers keep up with loan requirements such as real estate taxes and homeowner’s insurance premiums.k It also compensates Ginnie Mae issuer-servicers for the financial risks they undertake, as explained in Section 4.4.3a.

    Interest: Each month, interest accrues on the loan and is credited to the investors who own the loan. The interest compounds over time, and is paid to the investors all at once when the loan is repaid. (emphasis added)
    "Report to Congress on Reverse Mortgages", Consumer Financial Protection Bureau, June 28, 2012

A loan balance ("principal drawn plus accumulated interest, MIP, and fees") would seem to exist and grow annually, even if the line of credit is not used and the principal remains zero.
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by whaleknives » Thu Aug 25, 2016 5:45 pm

SuzBanyan wrote:. . .The annual amount looks easy to calculate each year during the life of the mortgage without predicting the future.

One of the many unknowns that would make calculating the present value of future payments difficult is how long the owners would stay in the home.
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by SuzBanyan » Thu Aug 25, 2016 6:10 pm

whaleknives wrote:
dodecahedron wrote:. . . The subsequent annual premium is a percentage of the accumulated loan balance, so those will be zero if the LOC is never tapped. . .

Here's what the Consumer Financial Protection Bureau said about annual costs in 2012:

    2.6.2 ONGOING COSTS & FEES
    Ongoing costs and fees consist of the monthly MIP (mortgage insurance premium), monthly servicing fee, and
    monthly interest.

    Monthly MIP: FHA assesses an ongoing MIP equal to 1.25 percent of the loan balance (principal drawn plus accumulated interest, MIP, and fees) per year on all loans, whether HECM Standard or HECM Saver.84 The 1.25 percent rate is an annual rate, but it is calculated and added to the loan balance on a monthly basis.85 Because of the negative-amortization feature of the loan, the MIP compounds in the same way that the interest does. Each month, borrowers are being charged MIP on a growing loan balance that includes prior interest and prior MIP.

    Servicing Fee: As with traditional mortgages, the servicing fee is embedded in the interest rate. Each month, servicers receive between 30 and 144 basis points (0.30 to 1.44 percent) before the accrued interest is credited to the secondary market investors.86 This fee is intended to cover the cost of sending the borrower account statements, disbursing loan proceeds, and ensuring that borrowers keep up with loan requirements such as real estate taxes and homeowner’s insurance premiums.k It also compensates Ginnie Mae issuer-servicers for the financial risks they undertake, as explained in Section 4.4.3a.

    Interest: Each month, interest accrues on the loan and is credited to the investors who own the loan. The interest compounds over time, and is paid to the investors all at once when the loan is repaid. (emphasis added)
    "Report to Congress on Reverse Mortgages", Consumer Financial Protection Bureau, June 28, 2012

A loan balance ("principal drawn plus accumulated interest, MIP, and fees") would seem to exist and grow annually, even if the line of credit is not used and the principal remains zero.

Let's do the math:

Principal draw down = 0
Accumulated interest = 0
Servicing fee imbedded in the interest rate = 0
Annual MIP = 1.25% of annual loan balance = 0
Fees paid with loan draw= 0

I keep coming up with 0 loan balance.

Of course, this assumes the homeowner pays the closing costs with cash and not with a loan draw down.

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dodecahedron
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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by dodecahedron » Thu Aug 25, 2016 6:34 pm

SuzBanyan wrote:
whaleknives wrote:
A loan balance ("principal drawn plus accumulated interest, MIP, and fees") would seem to exist and grow annually, even if the line of credit is not used and the principal remains zero.

Let's do the math:

Principal draw down = 0
Accumulated interest = 0
Servicing fee imbedded in the interest rate = 0
Annual MIP = 1.25% of annual loan balance = 0
Fees paid with loan draw= 0

I keep coming up with 0 loan balance.

Of course, this assumes the homeowner pays the closing costs with cash or lender credits applied against fees in exchange for higher contractual interest rate terms and not with a loan draw down.


^Text in red above inserted by dodecahedron.

Edited to add: basically this is exactly the same idea many of us are familiar with from conventional (forward) mortgages. Lenders will often offer to pay/waive up front closing costs on a 30-year mortgage in exchange for a higher interest rate. However, in the case of conventional forward mortgages, it is clear that they will generally recover their upfront fees unless the borrower elects to pay off the mortgage extremely fast. It is not so clear a HECM lender will recover their fee waiver, since there is no guarantee that the borrower will ever tap the LOC, and even if the borrower does tap the LOC, they may do so only shortly before they sell the home, die, or otherwise terminate the HECM.
Last edited by dodecahedron on Thu Aug 25, 2016 6:39 pm, edited 1 time in total.

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Re: "Ten Strategies for using a Reverse Mortgage to help fund retirement"

Post by whaleknives » Thu Aug 25, 2016 6:36 pm

SuzBanyan wrote:. . . Let's do the math:
Principal draw down = 0
Accumulated interest = 0
Servicing fee imbedded in the interest rate = 0
Annual MIP = 1.25% of annual loan balance = 0
Fees paid with loan draw= 0
I keep coming up with 0 loan balance.
Of course, this assumes the homeowner pays the closing costs with cash and not with a loan draw down.

You could be right, but I don't think there's such a thing as an FHA mortgage with a zero annual premium. This is why we're all waiting for mlebuf's update. :D
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