This is Bill Hornbeck, your reverse mortgage expert. So let’s talk about side 1 of the HECM Equity Triangle; that side which refers to the reverse mortgage.
Let’s get something basically straight here. This product, which is known as the reverse mortgage, is simply a cash-out refinance. It’s a home equity loan with one very special feature and that’s the fact that the homeowners have no requirement to make a home mortgage payment on a monthly basis. Yes, the loan will come due. But, right now we are going to go through an example to show you how this works in real life.
So…it’s a cash-out refinance. Let’s take this scenario; let’s say that we have a home valued at $500,000. Let’s say that the homeowners, husband and wife are both 75 years old. And let me remind you that you must be at least age 62 to qualify for this product. Let’s also say that we have an outstanding mortgage lien of $200,000 on this home. So we have a $500,000 home with two 75 year old owners and a $200,000 mortgage lien. We would look at that and say “hmmmm” OK $200,000 out of $500,000 is a $300,000 line of credit.
But let’s also know that the line of credit that’s made available to homeowners is really based on life expectancy and under a series of factors that determine how much money could be made available to someone at a certain value at a certain age of the homeowners. So we like to say that at age 62, you can receive a small portion of your equity whereas at age 92, you could get a larger portion of your equity.
Why?...well because the parties are most likely to die and that the loan will be paid off faster. So in this particular case, when we do the calculations…75 year olds…with a $500,000 value home…the equity actually comes out closer to $325,000 available to them. We have $325,000 available and we have a $200,000 mortgage existing. Well, we always have to pay off a mortgage. As a lender, we’re always going to remain in first position. So we’ll pay off that local bank. You’ll still owe, as the homeowner, that $200,000 mortgage. You just don’t have to make any payments on it.
What does that do? Well, it frees up cash flow over the course of each year. If you’re not making those mortgage payments, well, then that’s an amount of money that’s available to you to use in your lifestyle financial requirements.
So now we look at this and say “OK…if we have a line of credit available of $325,000 and we pay off the $200,000, and now you owe that with a new lender, that leaves $125,000 available. So we like to ask “How would you like that Mr. and Mrs. Homeowner?
Well, this is interesting. This is where the ‘reverse mortgage’ term was originated. Because early in the days of the reverse mortgage, which has only been around for about 25 years or so, the product was designed to be able to take that equity, to extract that equity and distribute it to the homeowner in monthly installments. Those earlier marketing advertisements by banks in the early days usually referred to something like “Hey, don’t pay the bank, let the bank pay you!” Well, the bank is not really paying you anything. You are actually extracting your equity in monthly increments and, in fact, you are borrowing your equity in monthly installments. But that’s perfectly OK. What you have really done is taken the value of money available to you at your age and turned that into a distribution. We’re taking certain calculations based on life expectancy and saying “OK, at age 75, maybe your life expectancy is 84…that’s 9 years…we’ll use some calculations to determine how much money that might be over the course of your remaining in the home.”
Because remember your choice at any time is to sell the home, right? Let’s not forget that. There’s always, in fact, maybe a more practical result in selling the home. But if you want to live in the home…to stay in the home, then this is a form of home equity finance to enable you to stay. So we’ll pay off the $200,000 mortgage. That leaves $125,000. And you can turn that into a monthly distribution. I don’t know exactly how much that is at this point. Depending on what the interest rate might be. But it could be, you know, several hundred dollars a month. OK, but you might say “Well, I don’t particularly want it in monthly installments. I would rather just stay there as a line of credit. Or, maybe just do both and kind of make it flexible. For example, I could say “Well, I have $125,000 available to me. Let me take $50,000 at settlement because I want to use that cash to maybe repair the roof, do some other repairs…maybe take that long awaited cruise.” But, in other words, use that money in a practical and responsible way.
If we did that. If we took $50,000 out at settlement, that would leave $75,000 in the line of credit. We might say, “OK, I tell you what, give me that $75,000 in monthly installments.” So now what we’ve done is we’ve had a combination…we have taken some cash out and we’ve also turned the other remaining cash into monthly loan proceeds. And you can really live in that home forever as long as you are taking proceeds on a monthly basis. Let me be clear…if you use only a line of credit and have spent all that money, well then there is no real additional expanded line of credit when you do that. But if you take it in monthly distributions, ie., a reverse payment, then you can in fact live in that home and receive that amount of money based on the value of the home, based on your age, based on the interest rates, and other certain factors to establish a certain amount of money that would come to you each month which, when combined with Social Security and, perhaps, another pension plan would be exactly the amount of money you need to maintain a monthly responsible debt service and income.
What we’ve really done here is, in one sense when you think about it, is chosen to stay in the home and use the equity as the monthly proceeds. I always like to say “It’s a bit like selling your home to yourself!” Think about that. If you sold the home, you would have the money…in this case you have a $500,000 home with a $200,000 mortgage and you walk away with $300,000. But now what are you going to do!?
Where are you going to live? How much rent are you going to have to pay? Are you really going to buy a smaller place? What are you going to do with the money? What about health care and other costs of living in your senior years?
It might be best just to remain in your home. So, in this case I say “OK, how about selling your home to yourself. Use the Home Equity Conversion Mortgage as a way to remain in the home, use some of the equity to live and, also, enable your home to appreciate over time and be able to raise your line of credit through aging…something we’ll talk about another time. But, do know that the line of credit can, in fact, expand as you get older. It’s a minor amount, but it just enables you to have more money to borrow over time. And let’s not forget…you are, in fact, borrowing your equity. It’s not free money. It’s not something that is given to you. It’s simply a cash-out refinance which says “OK Mr. Home Equity Conversion Mortgage Lender, I want to borrow from my equity instead of selling the home. You’ll give me a certain amount of money as I need it, which means I can turn it into reverse payments…I can leave it as a line of credit and call when I need it…or whatever I want to do in combination with that.”
But the rules are that, if I take the line of credit in monthly installments, I can live in the home forever. If I choose to take the money as a lump sum, I can in fact, find myself over-spent with an inability to pay my Real Estate taxes or homeowners insurance or homeowners association fees.
This is very important. There is no county in America that will let you live in your home without paying your real estate taxes. There is no difference with a Home Equity Conversion Mortgage, reverse or otherwise. You have a line of credit available to you. You also have a responsibility to pay those taxes as due, usually twice a year. If you fail to make those payments…if you fail to make your real estate property taxes, then you do have the risk of losing your home. Not because of the reverse mortgage…Not because of the Home Equity Conversion Mortgage…but because there is no county in America that will let you stay in your home without paying your real estate taxes. If you have a line of credit, make sure that you set that aside… the funds to properly pay that.
So, when is the Home Equity Conversion Mortgage, ie., reverse mortgage due and payable? At any of three events. One is if you move away, if you abandon your home. That is, you cannot abandon your home and live elsewhere as your primary residence. Look, each year you are going to receive a letter from HUD which stipulates in one sense…”I certify under penalty of law and risk of perjury, and all that, that this is my primary residence. It’s primarily for people to age in place. You can travel all over the world…you can live in Florida several months a year. You can live with your grandchildren or children and enjoy life over the course of the months of a year. But this home must be your primary residence. Put simply, it’s your address of record. This where you pay your utilities. This is where you pay your real estate taxes. This where you live..and you must certify to that.
If you abandon the home...if you move away, then under the terms of the loan this mortgage is due and payable. You know that going in…you know that along the way…there is no argument. You know you have to live in the home. If you no longer live in the home, the loan is due and payable. No, you cannot rent it. You cannot turn it into a commercial lease. It must be your primary residence.
So, of the three, one is you must live in the home…two, whenever you sell the home, the mortgage must be paid off. Well, of course…there is no way you can sell a home and not pay the lender, so that’s obvious. When you sell the home, your mortgage must be paid.
And, when you die…the last remaining dies…Dad died three years ago, mom just passed away. How does this impact the estate and the children? Well, I like to say at that time the line of credit is either more than or less than the value of the home. This about this. The time has passed. Over the course of several years, this loan has grown in debt level. That is, it’s a negative amortized loan. You’re not making payments…it doesn’t mean that they are not due. It simply means that when you are not making payments, the interest is accruing and the interest is compounded, meaning that interest is added to the amount of loan but over time the home debt level will have enlarged. Well, that’s OK because the property will also have enlarged in value over that time. So that even though the loan grows, the value of your home would normally grow and your family would be able to sell the home and pay off the mortgage and keep any profits that exceed the loan balance.
But, let’s take a look at another situation. Let’s say it’s the year 2007, 2008 and that home did not grow. And that $500,000 home is now worth $250,000. And let’s say that the loan balance has risen to $300,000. So you have a $300,000 mortgage debt and a home that is worth $250,000.
Well, here’s the beautiful thing about the product. There are insurance fees that are paid by the homeowners, which we will discuss at another time, but in this particular case those fees are held by HUD in order to insure two events. One is, for those people who have a reverse mortgage monthly distribution, those funds are guaranteed through the pool of funds available under HUD. They’re guaranteed, they cannot be lost. So you always have that money.
On the other hand, if your mortgage is in fact greater than the value of your home, you can sell your home at the lower of the value. That means that this mortgage debt of $300,000 over top of a home only worth $250,000…your family or you at any time can sell the home and pay off the mortgage at the lower value of $250,000. That is because of the pool of funds made available under the terms of this product with the fees that are paid to HUD. So, in the long run, this simply means that your home is yours for as long as you want to live in it…and that would extend to the fact that you can always sell your home. This is simply a mortgage…a cash-out refinance…with a deed of trust and a note just like any other mortgage. No, if you have ever heard that the bank owns your home, that is absolutely nonsense. The bank does not own your home…or at least not any more than any bank owns anyone’s home who happens to have a mortgage debt on it.
The property is yours to do with as you please. However keep in mind that the loan is only valid so long as you live in the home as your primary residence…if you sell the home, it has to be paid off…and when the last resident dies, the home will have to be paid off. And, of course, along the way, all real estate taxes, homeowners insurance, homeowners association fees must all be paid. And, since it is an FHA-insured loan, then the home must maintain the standards of repair that exist within the guidelines of the FHA.
That means that if your home has collapsed…if the roof is off…if the porches have detached…if there’s no railings…if there’s a whole series of things that would not qualify the home for any form of federal assistance or lending guidelines, then you would be required to fix that home to the level of requirements established by HUD. If you are unable to do that and there were no more funds available to do that, then your home could, in fact, be foreclosed upon under the terms of the mortgage.
That’s no different than any other scenario, so I always like to say that this is not because this is a reverse mortgage or a Home Equity Conversion Mortgage…but that’s true with all FHA loans no matter what. So just be confident that so long as you keep your home in good shape and can live in your home and pay your taxes, it’s a wonderful, wonderful advantage.
That covers essentially the reverse mortgage part of the program. In the next series of podcasts, we’ll take a look at the use of the Wealth Management side of the triangle to enable a very special home equity credit line. And also move towards the HECM for Purchase program. So stay tune for that.
For more information, please visit www.SeniorLifestyleMortgage.com
This is Bill Hornbeck, your reverse mortgage expert.