If you are 62 or over, you can use these Building Blocks to build your access to cash for use later in retirement.
As we age often there is a need for home care, accessibility remodeling, medical expenses, or other unexpected expenses, or that, with your retirement accounts alone, when you stop working you won’t have what you want in monthly income from the distributions. It is important that we plan for these needs and possible expenses. One way to help with that is with the Unique Feature within a Home Equity Conversion Mortgage (HECM), commonly called reverse mortgage.
Even though a Home Equity Conversion Mortgage loan is designed to have no monthly mortgage payments during the life of the loan, you can make payments on a HECM loan just as with a conventional mortgage. That is when the Unique Feature of the HECM loan helps you build cash for later.
Unique feature of the HECM Loan is the Line of Credit: Any amount you pay into the reverse mortgage with a Line of Credit, first goes to pay off the interest, then reduces the principal, AND the full amount of your payment is ALSO credited to the Line of Credit. That means that you can get that money (and more) back out of the loan any time you want it. Here is why you can get more back than you put in. HUD requires the lender to increase the amount of the HECM Line of Credit by a rate of 1.25% more than the interest rate of the loan, compounded monthly. That means that you can build access to more cash later in retirement. See the chart below for an example.
Here is how using the Home Equity Conversion Mortgage (HECM) in place of a conventional loan will optimize your payments into your home loan by 1.) reducing your loan balance, and 2.) building access to more cash in the future, while also 3.) protecting your home equity from a possible decline in the real estate market.
1. Refinancing your existing mortgage with a HECM loan. You currently have a home loan, and you are financially able to make the payments. If you choose to refinance your current loan with a HECM loan, you would build your home equity and build access to cash at the same time. You continue to make loan payments into the HECM loan, just as you have done on your current loan, and here is what would happen: First, the payment would pay the interest and reduce the loan balance increasing your home equity, just as it does on your current loan. Second, the whole amount of your payment would be credited to the Line of Credit. This means that you could pull the money you paid into the Line of Credit back out anytime you want. With your current loan, once you paid the money in, you have lost any access to it. Third, as you read above, the Line of Credit grows over time with compound interest. This means that, in the future, you will have access to even more money than you put in. See the Example chart below.
2. Downsizing, moving into another more desirable neighborhood, or getting your dream home. In this scenario you will be selling your current home to buy another, and you COULD financially qualify for a conventional loan. You have enough income to make payments. You would choose to finance your new home purchase with the HECM reverse mortgage instead of using a conventional loan, and you would make the same monthly payments into the HECM loan as you would have with the conventional loan. This way you take advantage of the Unique Line of Credit feature and build access to cash for later in retirement. This works the same as the example above by paying down the loan and building your line of credit at the same time.
Example of Using a HECM Loan to Build Cash
For example, let’s say you purchased a $600,000 home and financed $300,000 (or you refinanced a $300,000 loan) with the HECM loan, and you made the same monthly payment that you would with a conventional loan — $1,475 per month. Here’s what would happen in 15 years:
Reduced home loan and access to more money than you borrowed. The chart above shows that your monthly payment of $1,475 was credited to both your loan and your Line of Credit. The payment reduced your loan balance to $208,000, just like a conventional loan. But also, your Line of Credit increased to $370,000. That increase is due to compounding interest of the growth rate that is applied to your Line of Credit balance each month. You can see from the chart that in 15 years you could actually get back more cash than you originally borrowed by using this strategy.
Results: With this strategy you also accomplish two goals. A. You have a home that you want for the rest of your life. B. You have access to even more cash than you borrowed in the first place to use later in retirement for living expenses, home care, accessibility remodeling, unexpected expenses, etc.
There is an Added Benefit — The monthly payments are NOT required; they are voluntary. That means that if your income is impaired in some way, you will not be risking foreclosure by not paying a mortgage payment. Or, you may want to use your money from a couple of months payments to go on a great vacation, whatever. All you are required to do to keep the HECM loan current is pay your taxes, insurance, (HOA dues if any), and keep the home livable, just as you would with any other loan, but you do not have to make monthly loan payments if you don’t want to.
Protecting your equity — There are times when the housing market takes a major downturn and the value of your home may be significantly reduced. In Southern California during the last major downturn we have seen homes in some counties lose 60% of their value. Using the above example, the value of that home would drop from $600,000 to $240,000. If that did happen, and you had the HECM loan as shown in the example above, you would be able to draw from the Line of Credit $370,000. That is $130,000 more that the value of the home. You could draw that $370,000 out, use it for whatever you want, AND continue living in the home as long as you want. So you have protected a portion of the equity in your home while still having access to cash.
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More Detailed Explanation With Graphs for Finance Minded People and Professionals
Why Should Folks 62+ Explore A Home Equity Conversion Mortgage And The Income Optimizing Strategy?
If you are 62 or over with a mortgage lien on your primary residence, obtaining a conversion mortgage and deploying the Income Optionality Strategy provides options you will not have with a traditional first or second mortgage or a Home Equity Line of Credit (“HELOC”). The information and charts below illustrate some of the differences. It is important to know that a conversion mortgage has, in some cases, slightly higher costs compared to traditional refinances or HELOCs, but the gains available and the overall program features provide a greater reward.
How Does The Income Optionality Strategy Work?
Paying off a traditional mortgage with the loan proceeds from a conversion mortgage that is set-up with a line-of-credit (“LOC”) feature is the first step. The key to this strategy is what you do next.
Even though a conversion mortgage does not require monthly repayments, making monthly payments has its advantages. If you continue to make monthly payments, as you were on your traditional mortgage, while you reduce the conversion mortgage balance, you also increase your Line of Credit available for future use. That is, every dollar you pay in first pays the interest, then reduces the principal as with a traditional mortgage, however the full amount of your payment, dollar for dollar, is credited to the Line of Credit. You have the right to draw any or all of that money back out any time you want.
In addition, the Line of Credit has a growth factor of 1.25% more than the interest rate of the conversion mortgage. That means over time the compound interest is working in your favor, giving you access to more and more cash whenever you may need it. Once you have paid the unpaid principal balance down to a $50 minimum required balance, you have reached ultimate “optionality”. You will have a sizable line-of-credit that will continue to grow, you can draw upon the Line of Credit as tenure payments, term payments, single or multiple disbursements as you need it, or you can enjoy the optimal gain on sale if you choose to relocate. The charts below illustrate the use of this strategy as compared to a traditional mortgage.
How a Traditional Mortgage Works
On a traditional mortgage (below), monthly payments result in increased net equity as more principal is paid down. If the homeowner were to sell the home after the mortgage is paid off, the resulting net equity would be dependent upon the home’s value at that time. This is shown here as “GAIN ON SALE”.
If the home’s value appreciates more than expected as shown at point ①, the gain on sale would naturally be greater. However, if the home’s value does not appreciate as expected, shown at point ②, the funds that could be accessed by selling the home could be much less.
Traditional Mortgage Comparison Points
- Monthly principal and interest mortgage payments are required.
- Interest accrues monthly on the used portion of the loan.
- With each loan payment, the portion of the payment applied to principal will reduce the loan balance.
- Equity in the home can be accessed by selling the home, refinancing or obtaining a HELOC, all of which come with negative cash flow of a monthly repayment requirement.
- The costs associated with refinancing to access home equity may include, and may not be limited to, broker and/or lender loan origination fees, discount points, processing, underwriting, document preparation, mortgage insurance (depending on LTV), closing costs, recording fees, and interest.
- The costs associated with selling your home to access home equity may include, and may not be limited to, broker and/or lender loan origination fees, discount points, processing, underwriting, document preparation, mortgage insurance (depending on LTV), closing costs, recording fees, interest, real estate commissions, moving costs, and the costs associated with renting or purchasing another home.
How a Conversion Mortgage Works for You
On the conversion mortgage graph (below), you will notice that a Line of Credit is established, as indicated by the green line. This happens when the conversion mortgage begins. Every payment that is made to pay interest and reduce the unpaid principal balance boosts the Line of Credit dollar for dollar. This growth factor of 1.25% more than the interest rate of the conversion mortgage was mandated by HUD and is unique to conversion mortgages. The Line of Credit grows independent of the value of the home. So even if the home value declines, the Line of Credit grows. The growth factor makes this program a powerful financial tool for successful aging-in-place and funding longevity.
If the home’s value appreciates more than expected as shown at point ①, the gain on sale could be greater. However, if the home’s value does not appreciate as expected, as shown at point ②, and the borrower wanted to sell, they could draw out the funds from the Line of Credit that exceed the home’s value, then sell the property, actually realizing more that the market value of the home. Otherwise, they still have the option of using the entire amount of the Line of Credit with no negative cash flow, no payments. Note: this strategy feature can act as a hedge against home price decline.
Conversion Mortgage Comparison Points
- No monthly principal and interest mortgage payments are required.
- Interest accrues monthly only on the used portion of the loan.
- With each optional loan payment, the portion of the payment that is applied to principal will reduce the loan balance.
- A Line of Credit, representing the remaining principal limit, would be established at closing.
- The available Line of Credit will grow at the current note interest rate plus 1.25 percent.
- The value of the Line of Credit in not limited by the home value and has the ability to grow and exceed the value of the home without penalty; therefore, the Line of Credit will act as a hedge against declines in home value.
- The Line of Credit can be converted to structured payments sent to you at any time.
- You have the ability to cease or reduce the amount or number of regular payments at any time.
- Equity in the home can be accessed by:
- o Requesting draws from a Line of Credit
- o Setting up tenure, term, or single disbursement payments, or
- o Selling the home.
- The costs associated with accessing home equity with a conversion mortgage may include, and may not be limited to, broker and/or lender loan origination fees, document preparation, upfront and monthly mortgage insurance, closing costs, recording fees and interest.
Call or contact me for a no-obligation confidential in-home appointment to see how this program could work for you.
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Useful Links: National Reverse Mortgage Lenders Association, Find a HECM Housing Counselor, FHA Reverse Mortgages for Seniors, Frequently Asked Questions about HUD’s Reverse Mortgages, New rules for reverse mortgages, AARP Living on a budget, US Government Senior Citizens’ Resources, California Department of Aging, Senior Resources State of California, Your Guide to Public Benefits, Home Care: Financial Assistance and Payment Options, California Senior Gateway, Top 10 Safety Tips for Seniors, Community-Based Adult Services, Long-Term Care Ombudsman Program, Legal Assistance, Supplemental Nutrition Assistance Program-Education, Disease Prevention and Health Promotion, Los Angeles County Department on Aging, Consumer Protection for Seniors, End-of-Life Issues, Caregivers’ Resources, Grandparents Raising Grandchildren, Money and Taxes for Seniors, Travel and Recreation for Seniors