A lot of seniors like the idea of a Home Equity Conversion Mortgage (HECM) -- until they see the upfront costs. While HECMs can be lifesavers in the right circumstances, HECM costs can be prohibitive when you only need a modest amount of money. But a new product may change all that.
One drawback of FHA reverse mortgages, or HECMs, is the upfront cost of the mortgage insurance premium (MIP). Unlike regular FHA mortgages, which carry mortgage insurance based on the loan amount, HECM mortgage insurance is calculated as a percentage of the property value. That means that a 2 percent upfront mortgage insurance premium based on a $500,000 property value could be 4 percent of the reverse mortgage proceeds if you are restricted to a maximum loan amount of $250,000. That's $10,000 right off the top.
HECM proceeds drop, while costs remain the same
Recent changes in HUD's policies have exacerbated this trend. To restore its reserves, HUD has reduced the amount that can be borrowed with FHA reverse mortgages by 10 percent. So, if your maximum loan amount was $250,000 before the change, it's $225,000 now. But the cost stays the same. So, if you have to pay upfront mortgage insurance of $10,000 on that $500,000 property, but only get $225,000 in proceeds, the insurance becomes 4.44 percent of the proceeds. That's not counting the annual premiums of .5 percent and the mortgage interest charged.
You can see how impracticable this would be for smaller amounts. If a senior opted for a monthly income of $2,000 per month, and then moved or died in five years, he or she would have received only $120,000. The upfront insurance would have cost 8.3 percent of the proceeds. If he or she had a line of credit and only tapped it for $20,000, the cost is a whopping 50 percent!
HECM proves costly for the government, too
Despite the high cost of insurance, the program isn't raking in profits for HUD. HECM programs rely on steady home price appreciation to remain solvent. The areas of the country with large populations of elderly people, like Florida and Arizona, have experienced a lot of negative appreciation in the last three years. So if three years ago a senior received HECM proceeds equal to half the property's value, and today the home is worth half of what it was then, and the balance continues to grow as interest accumulates, there could be a huge loss on this non-recourse mortgage. Repeat this scenario all over the country, and it becomes obvious that the program can't be sustained under these conditions.
So isn't a home equity line of credit (HELOC) a better deal?
HELOCs cost little or nothing to set up, and there is no mortgage insurance to worry about. So why wouldn't seniors just choose HELOCs or home equity loans? They would if they could qualify. Second mortgages require monthly payments from the homeowners, and retirees in need of money aren't likely to be able to qualify for a HELOC or home equity loan. Finally, taking the proceeds with a reverse mortgage may prove more reliable, as homeowners have found that when real estate markets soften and the economy goes south, lenders may cut access to home equity lines of credit without warning.
The best of both worlds: HECM Saver!
HECM Saver is a new program that came online in October 2010, and it lets seniors take out something very close to a traditional home equity line of credit (HELOC).
Like the HELOC above, the upfront costs of HECM Saver are a fraction of those of a standard HECM, making it an appropriate choice for smaller projects or as a hedge against emergencies. The percentage of home equity that can be tapped is lower -- but in exchange for agreeing to a smaller loan, the borrower pays a much lower upfront mortgage insurance premium -- almost nothing, in fact.
The 0.01 percent (that's not a typo - it's one hundredth of one percent) upfront mortgage insurance premium is nearly nothing. So instead of the $10,000 in upfront mortgage insurance premium required on a $500,000 property, a homeowner would pay $50. Then, he or she would pay 1.25 percent of the loan's balance each year for mortgage insurance. Borrowers who hit a credit line for $20,000 would pay just $250 that year for the annual mortgage insurance. (This fee will of course increase as the balance of the loan grows.)
The HECM Saver program could accomplish several objectives: First, make cash available to the neediest seniors at a lower cost. Second, the program is expected to help replenish the HECM program's dwindling reserves which have been dwindling. Third, this extra cushion should keep HUD from reducing the amount of equity that seniors would be able to access under a traditional HECM plan.