Many elderly homeowners want to remain homeowners but not in their current house. They may want a house that is smaller, or without stairs, closer to family or friends, in a warmer climate, or whatever. If they are over 62, a HECM reverse mortgage may ease the financial pain of the purchase.
There are three ways to acquire a new house while taking out a Home Equity Conversion Mortgage (HECM), which is a reverse mortgage.
- One way is to pay all cash for the house, then reverse mortgage it.
- The second way is to buy the new house with a forward mortgage small enough that it can be paid off with the proceeds of the HECM.
- The third way is to purchase the house and take out the HECM in one transaction under the "HECM for Purchase" program authorized in 2008.
These will be considered in turn.
Buy with all cash, then do a reverse mortgage
Paying all cash for your new house is the simplest way to go. You can then take out a HECM to replace some of the assets you liquidated to purchase the house, or for any other purpose.
Paying all cash has some advantages over using a HECM to make the purchase. If you want to have the new house constructed to your specifications, for example, you can’t finance construction with a HECM. However, not many seniors have the free cash required to pay all cash, and tapping retirement accounts is resisted, for good reasons.
Buy with a forward mortgage, repay with a reverse mortgage
Prior to the HECM for Purchase program, the senior who wanted to purchase a house but could not afford to pay all cash had to take out a forward mortgage to buy the house, then repay it by drawing on a reverse mortgage.
Because the senior had to qualify for the forward mortgage in the same way as any other home purchaser, insufficient income or poor credit could bar the way. Furthermore, the senior who did qualify had to pay settlement costs on both the forward mortgage and the HECM. The new "HECM for Purchase" program eliminates these problems.
Buy with a reverse mortgage
In 2008, Congress authorized a "HECM for Purchase" program, under which seniors can buy a house and take out a HECM reverse mortgage at the same time, incurring only one set of settlement costs. The senior need not be a homeowner but can become one with the aid of the HECM. The program cannot be used to construct a new home, but it can be used to purchase one that is newly constructed and approved for occupancy by the city. The senior must physically occupy the home as his or her permanent residence within 60 days of purchase.
Seniors using this program must have the means to pay the difference between the sale price of the property (plus settlement costs) and the maximum amount they can draw on the HECM. The maximum draw is based on the lower of the sale price, appraised value and FHA’s maximum loan amount.
As an illustration, a senior aged 70 purchasing a $400,000 house on June 12 could finance about $250,000 with a standard HECM. (Older buyers could draw more, younger buyers less.) The remaining $150,000 would have to be financed out of the senior’s resources: liquidation of assets or withdrawals from retirement accounts. Gifts from family and friends are also acceptable funding sources, but gifts from the home seller or anyone else involved in the purchase transaction are not.
Seniors using the HECM for Purchase program can select either the standard or Saver version, and either an adjustable-rate or a fixed-rate version — four choices in all. The Saver version offers a lower upfront charge in exchange for a smaller draw, and should appeal only to purchasers who don’t intend to remain in the home very long. Most purchasers will and should opt for the standard HECM.
In the current market, fixed-rate and adjustable-rate HECMs have about the same maximum draw. If I were taking the maximum draw, I would select the fixed-rate HECM because when interest rates begin accelerating, my loan balance would continue to grow at the fixed rate. If my house appreciated significantly, I could refinance and draw more cash sometime down the road.
However, if I wanted to use less than half of the maximum draw to purchase the house, retaining the rest as an unused credit line, the adjustable-rate HECM might work out better in a rising-interest-rate environment. While the amount I borrowed would grow at the rising rate, my unused credit line — the amount I could have borrowed, but didn’t — would also grow at that rate, expanding my future borrowing power.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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