Options for Moving in Retirement Using the HECM for Purchase

Transcription

1 Options for Moving in Retirement Using the HECM for Purchase By: John Salter, Ph.D., CFP SUMMARY Many retirees will choose to move from the large home in which they raised their family into something smaller and more manageable to maintain. These retirees will be faced with the financial decision of how to best finance their new home. Traditional financing options exist which include paying cash for the home, or using a traditional mortgage. One newer, and lesser known option, is the Home Equity Conversion Mortgage (HECM) for Purchase, where the HECM reverse mortgage can be used directly for the purchase of a new home. INTRODUCTION As baby boomers enter retirement many will decide whether to stay in the larger home in which they raised their family or move to something smaller and more manageable, and one which better fits their lifestyle. Larger homes require more time and expense in cleaning, repairing, maintaining the yard, and many other factors. The idea of?right-sizing,? or finding an alternative that better meets their needs may take into account these factors in determining the choice of a new residence. An example may include the retiree who enjoys traveling and may want to move to a home which requires little maintenance while they are away, such as a garden home or condominium. Many of these factors may be more qualitative, or related to lifestyle, rather than pure economic decisions. Financial decisions may include lowering expenses such as utilities, real estate taxes, cost of maintenance and upkeep, as well as simply purchasing a less expensive home in order to free home equity to be used for funding future goals. One major financial decision is how to approach financing the new home. Traditionally, we have relied on two main methods: paying cash or using a traditional mortgage. Many retirees have an aversion to debt, particularly with carrying a mortgage into retirement. For these retirees, the optimal method of purchasing a new home would be paying cash and being mortgage-free. However, for many retirees this option may not be an option. Funds would need to be available either from the net sale of the old home after paying off any existing mortgage or from alternative asset sources, such as retirement savings. One major factor in using retirement assets to purchase a new home is the tax liability from a lump-sum distribution from retirement accounts, where a retiree may pay more in taxes by distributing a large amount from retirement plans for the purchase. Alternatively, a retiree may choose to obtain a traditional mortgage for their new home. In this scenario, the retiree would only be responsible to pay the minimal down payment required, and would then finance the remainder of the purchase for the desired loan term. In this scenario, the retiree would have more flexibility in resources after the purchase. One major risk to consider is future cash flow consistency. Traditional mortgage payments are required and should any decrease in cash flow occur, the mortgage payment is not something the retiree can defer. Results in this scenario include becoming delinquent, thereby negatively impacting the retirees credit score, needing to sell the property to eliminate the mortgage payment or, at worse, foreclosure of the property. 1

2 One newer and lesser known option for purchasing a home in retirement is the HECM for Purchase program, where the proceeds of the mortgage are used to partially fund the purchase of a new home. The HECM for Purchase was implemented by U.S. Department of Housing and Urban Development to allow retirees the financial ability and flexibility to move during retirement for circumstances such as relocating closer to family or purchasing a home better physically suited for them. PRIMER ON HECM FOR PURCHASE The HECM for Purchase provides many benefits as well as flexibility for the retiree to consider. First, repayment of the loan is not required, but is allowable. After closing, the homeowners can make payments toward the loan 1, if they desire, and at the pace they desire, providing flexibility and protection against cash flow fluctuations. A retiree may choose to not repay at all as well. In this scenario, the debt would compound over time and be paid upon sale or death. The HECM program is a non-recourse debt, so the debt owed upon sale or death is guaranteed by FHA to not exceed the home value. In the worst case, there would be no equity remaining at sale or death. The HECM for Purchase program is similar to what we know as the HECM reverse mortgage, with the difference being that the home is not required to be owned prior to initiating the mortgage. Otherwise, the requirements to obtain the HECM for Purchase are alike, and are as follows: - At least one homeowner must be at least age 62; - The subject property must be the owner?s primary home; and - Home must be single-family, FHA approved condominium, up to a 4-unit home, or a manufactured home. After obtaining the HECM for Purchase, the following requirements must be met: - Taxes and insurance must be paid when due; - Home must be maintained over time; and - The subject property must be the borrower?s primary residence. The loan amount available in the HECM for Purchase program, or the principal limit, is a function of the youngest borrower?s age, the value of the home, and forward-looking interest rates. These factors are the inputs into what is known as the Principal Limit Factor (PLF), or the percent of the home value available. The PLF factors are determined and published by Housing and Urban Development. - Age of youngest borrower? the factor is determined based on the age of the youngest borrower, or the eligible non-borrowing spouse less than 62 years old. The older the youngest spouse, the higher the PLF. In essence, the program provides?age credits,? whereby the PLF increases with age. This is due to the time debt can compound, younger borrowers have longer time for the debt to compound and grow. - Value of the home? the program requires a formal property value appraisal, and this appraised value is used as the value of the home. One important note is the maximum home value allowable in the formula is $636,150, meaning a HECM for Purchase can be used on a $1 million home, but the maximum value in the loan amount calculation is limited to $636,150. The $1million home would have the same loan amount available as a $636,150 home. - Forward looking interest rates? the Principal Limit Factor is currently based on the 10-year LIBOR Swap Rate. Like age, expected interest rates impact the compounding of debt over time, so the higher the expected rates, the lower the PLF. In recent years, and still today, we have been in a low-rate environment where PLFs have been higher. As rates continue to increase, PLFs will decrease. 1 Interest is paid first, and may be deductible. Not tax advice. Consult a tax professional. 2

3 The costs to obtain a HECM for Purchase are also like those of other HECM programs. Up-front costs include origination fees, an FHA mortgage insurance premium, counseling fee, and other costs typical of traditional mortgages. - FHA Mortgage Insurance Premium (MIP)? FHA guarantees two aspects of the HECM product. First, the non-recourse feature described above, and second, in the event the lender becomes insolvent. The MIP is calculated in two manners, depending on the initial amount borrowed: - Less than 60% of available credit dispersed in first 12 months: 0.5% of the home?s value. - Greater than 60% of credit dispersed in first year: 2.5% of the home?s value. - Origination fees are charged by the lender related to their cost of originating the mortgage. A limit exists on the amount a lender can charge, which is 2% of the first $200,000 of home value and 1% of the value over $200,000, up to a maximum $6000 total origination fee. - Other costs include those like a traditional mortgage include title fees such as title insurance, recording fees, document preparation, etc. as well as a formal property value appraisal. - The HECM program also requires a formal, third-party counseling session which generally costs $125. The purpose of counseling is to help ensure the homeowner understands the reverse mortgage program before closing. In addition to the up-front costs, the HECM includes the ongoing cost of borrowing. The HECM programs either have a fixed rate, or a variable rate. Variable rates are generally for line of credit options, and fixed rates are commonly selected by the borrower for full, initial dispersion of money (or loan amount) made available. For variable rate HECMs, the ongoing cost is the sum of the following: - FHA MIP of 1.25%; - Lender margin, generally between 2% and 4%, which is a fee paid to the lender over time; - One-month LIBOR rate or the one-year LIBOR rate (the borrower chooses). In the above, the one-month LIBOR rate is the portion of the borrowing rate which is variable. The fixed portion essentially incorporates the MIP and lender margin, but fixes the portion of the rate related to LIBOR. (For line of credit options, the above describes both the borrowing rate and the growth rate of the line of credit). EXAMPLE HECM FOR PURCHASE SCENARIO As an example, let?s take a retired couple, husband is age 65 and wife age 62. They desire to purchase a new home worth $300,000. In today?s environment, the couple would have a PLF, based on Wife?s age of 62, of 52.4%. The amount of money available for use in the HECM for Purchase would be $157,000. In this scenario, the couple has up to $157,000 of the $300,000 able to be financed in the HECM for Purchase. The remaining $143,000 would be financed from proceeds of the sale of their old home or from other financial assets. If we assume the couple sold a $500,000 with no mortgage, they would have $357,000 after the purchase to use as they wish, as well as having flexibility in making future payments. Up-front costs in this example would include the following: - Maximum origination fee of $5,000; - Up-Front Mortgage Insurance Premium of $7,500, as greater than 60% of the initial $157,000 was used. - Other closing costs, including counseling, would vary by location, but per the National Reverse Mortgage Lenders online calculator, would be approximately $2,

4 It should be noted that a few lenders are not charging an origination fee which reduces up-front costs to clients, especially on higher value homes. Furthermore, it should also be noted that when clients use the other payment options, such as a credit line or monthly payment, a few lenders are providing significant lender credits that can reduce the initial costs to clients, especially on higher value homes, to as little as $ The couple would have the option to use a portion of the funds available, to include these up-front costs as part of the HECM for Purchase loan. The current estimated fixed rate interest (including the FHA mortgage insurance premium) on borrowing would equal 6.3%, which is the rate the loan would compound over time. EVALUATING THE USE OF THE HECM FOR PURCHASE What might be the best way to evaluate the optimal use of the HECM for Purchase is by the overall financial status and overall financial resources of the retiree. The following evaluation will focus on two groups, those with limited financial resources who essentially have little choice in purchasing a new home, and those with the choice of either paying cash or seeking other funding alternatives such as traditional mortgages or reverse mortgage strategies. LIMITED FINANCIAL RESOURCES Unfortunately, the national statistics consistently conclude many retirees will fall into the category of limited financial resources. These retirees would be those with limited retirement savings and limited fixed income sources. Retirees in this category will have limited financial options when looking to new home options. The HECM for Purchase may be most applicable to these retirees, particularly because there are not many other options available. Paying cash may or may not be an alternative, however paying cash will also lock the value of the equity in the home, and a portion of this equity could be used for maintaining a future standard of living. Qualifying for a traditional mortgage would likely be an issue, as income and resources are limited. As an example, Husband and Wife who are both 80, decide they need to move to a new home to be closer to family, which is in a higher priced area, to help with their care. The couple has $25,000 left in savings and a house which is paid for worth $200,000, and the new home will cost $250,000. Both Husband and Wife are on limited fixed income, and likely would not qualify for a mortgage. They do not have the available resources to pay cash. This is the scenario where the HECM for Purchase was designed. Using the HECM for Purchase, their principal limit on the reverse mortgage would be $151,000. After maximum closing costs estimated at $13,000, the couple would have $138,000 to help finance the new purchase. The couple would then be responsible for only $112,000 of cost of the new home, and after the $200,000 sale, would net $88,000 to add to their $25,000 nest egg, increasing their total nest egg to $113,000 to be used for future living and expenses of care. In this example, assuming the couple did not make payments in the future, their loan would obviously compound over time and erode the home equity over time relative to bequests to heirs. However, the couple moved closer to family for their help in care, thereby saving money from other healthcare avenues and lessened the chance of also being a financial burden on their family. 2 With this pricing option, borrower receives a lender credit covering nearly all closing costs. Up-front cost shown is for a non-refundable independent counseling fee of approximately $125 on average, which the borrower pays directly to the counseling agency. Not available in all states. Certain conditions and fees apply. 4

5 The HECM for Purchase may be the best alternative for those with limited resources who do not have the alternative resources available to pursue either fully purchasing with cash or obtaining a mortgage. In addition, the HECM for Purchase for these retirees may open additional financial resources for future use in maintaining their standard of living, for healthcare costs, or for renovating homes to meet physical needs. For retirees with limited income who can pay cash for their home, the HECM for Purchase should still be considered to extract home equity for future financial use. In addition to the HECM for Purchase, the line of credit or tenure payment option should also be considered. If we change our low resource example to selling a $250,000 home to buy a $250,000 home, here are the three ways these retirees could benefit from the three HECM programs: - HECM for Purchase? scenario would remain the same, however the retirees would net $138,000 to add to their nest egg, increasing their savings to $163, Line of Credit? rather than incur debt up-front, the retirees could set up a line of credit option using the HECM program. Their initial line of credit would equal the principal limit. In the case of this 80-year-old couple, their credit line, net of closing costs, would be $120,519. Closing costs could either be paid directly or financed by the HECM, but either way less than 60% of the proceeds would be used so closing costs in this example could be less than $2,000. The unused line of credit would then grow by the before mentioned formula monthly, and the retirees could draw from the line of credit as needed, or when their savings depleted. 3 Currently, the growth rate for credit line is approximately 7.07%. This means that in ten years the couple?s available credit line would grow to $281,325, which exceeds the original value of the home. - Tenure Payments? the home equity can essentially be?annuitized? into lifetime payments. In this scenario, the couple could receive an approximate additional $8,000 per year. Each payment is a loan distribution, so the loan accumulates as payments are made. - Combination of the above? the HECM program provides a high level of flexibility in benefit types, including the ability to combine any of the above. For example, less than 60% of the principal limit could be used for purchasing a home, saving 2% of the home value in MIP closing costs, and the remaining 40% could be kept as a line of credit. GREATER FINANCIAL RESOURCES As financial resources increase, so do options of purchasing the new home. Retirees with adequate income, such as Social Security related to higher earnings, corporate pension plans, etc. and those with higher levels of retirement savings may have the luxury of multiple financial avenues of purchasing the new home, including paying cash, obtaining a mortgage, or using the HECM for Purchase. For this discussion, we revert to our first retiree example of our 65 and 62-year-old couple. They were selling their $500,000 home to purchase a $300,000 home. The couple has $500,000 in retirement assets, so enough to fund even purchasing a somewhat more expensive home. The basic question is, from a financial planning perspective, what is the best option for this couple? The answer is, as it often is in financial planning, it depends. - First, from a financial planning perspective, we can eliminate paying cash without implementing a HECM strategy as inferior from previous research. In all financial planning research related to reverse mortgages, strategies implementing a HECM are always superior to ignoring the home equity. The reason why should be obvious, the HECM allows the use of home equity in generating or protecting retirement income. 3 If part of the borrower?s loan is held in a line of credit upon which you may draw, then the unused portion of the line of credit will grow in size each month. The growth rate is equal to the sum of the interest rate plus the annual mortgage insurance premium rate being charged on your loan. 5

6 - Obtain a traditional mortgage can be deemed inferior as well; though a traditional mortgage is leveraging the portfolio over time, a risk is introduced through the fact traditional mortgage payments are required. Should a point arise where payments cannot be made, the decision must be made to sell the home, likely with damage to credit scores from missing payments. Alternatively, the remaining balance could be refinanced into a HECM in the future, but risk remains related to future interest rates and the PLF available, as well as risk of policy changes related to the HECM program itself. In addition, this strategy is not extracting any value from the home equity available, and as mentioned, strategies incorporating the direct use of home equity have been deemed superior in previous research. The remaining two strategies to consider in proactively using home equity in the retirement income solution are: - Obtain a HECM for Purchase? as mentioned, the HECM for Purchase would alleviate the risk of the inability to make future mortgage payments since repayment is optional, and would also result in increasing retirement assets using the previous home sale proceeds as a down payment on the home. The unused proceeds from the previous home sale could then be invested for future use along with the other retirement assets. The HECM for Purchase would result in a current debt, which without repayment would compound over time with the possibility the loan value exceeds the home value, though the non-recourse feature would keep the homeowner from being under water. Nevertheless, there is the possibility the net value of the home in the future is zero. Essentially, the couple would be leveraging their portfolio using the HECM for Purchase loan. - Pay cash for the home and establish a line of credit? the HECM line of credit would alternatively result in the principal limit being available in a secured line of credit rather than available for investing. The unused line of credit grows over time at the previously discussed rate, and does so independent of the home value. This growth feature provides future protection on an as-needed basis. Should the line of credit never be used, there is no debt to repay. 4 Should funds be borrowed, the same repayment flexibility exists as with the HECM for Purchase. Existing retirement assets would be used first, relying on the growth in the line of credit for future use. Essentially, the couple would be leveraging the line of credit using their portfolio. Determining which of these is the superior strategy relies on the goal of the couple. In financial planning, the risk and reward of any strategy must be weighed. At times, there may be strategies where the risk and reward are tradeoffs between maintaining a standard of living versus possibly having more assets in the future. Selecting between these two strategies involves this consideration. Going back to our couple, the optimal solution can be evaluated by performing simulations related to their future through Monte Carlo Modelling. The following assumptions were incorporated into the analysis related to the example couple year-old couple, life expectancy of Spending needs: $28,000 per year, adjusted by inflation. - Portfolio: 50% Equity/50% Fixed Income, Rate of Return 6.3%, Standard Deviation 10.3% - HECM for Purchase Fixed Rate: 5.3% - HECM PLF: General Inflation: 3% - Real Home Appreciation: 0 - LIBOR: 2.8% - Lender Margin: 3% - Number of Scenarios: 1,000 4 HUD requires a minimal ($1 or more) loan balance for the line of credit to remain open. 6

7 PAYING CASH AS A BASELINE Our 62-year-old clients sell their previous home for $500,000 and directly purchase their new home worth $300,000. At the end of this transaction, they have $200,000 they can add to their portfolio to help fund future needs, however no HECM strategy is implemented. Our client would have a probability of meeting their lifestyle needs of 78% after 30 years, a median net worth of $1.3 million, and a median portfolio value of $666,000. Probability Median Portfolio Median Net Worth 78% $666,000 $1,200,000 HECM FOR PURCHASE STRATEGY In the HECM for Purchase strategy, our 62-year-old couple sells their old home for $500,000. Based on the PLF, the HECM for Purchase proceeds available for down payment on the new home is approximately $157,000. Assumed closing costs of $13,000 are included in the loan, resulting in $144,000 being available for financing through the HECM for Purchase, which is also the amount being leveraged. Of their $500,000 old home sale proceeds, $156,000 is used as a down payment on the new home. The couple?s retirement portfolio increases from $500,000 to approximately $844,000. After running 1,000 possible futures for the couple through the Monte Carlo simulation, the percent of scenarios funding their lifestyle after 30 years is near 88%. Their median portfolio value is near $1.2 million. Because the loan was never paid back, and by age 90, the loan?s accumulated value of $924,000 has exceeded the estimated home value of $707,000. The non-recourse feature of the HECM loan would limit the loan payable upon sale or death to the value of the home. Hence, the $1.2 million portfolio value in this case is our client?s net worth. In this case, though the loan value over time has absorbed the home value, the additional amount invested in the portfolio has outpaced what would have been the appreciation of the home?s value, resulting in a possible higher bequest amount, or more available if the clients were still living. Probability Median Portfolio Median Net Worth 88% $1,400,000 $1,400,000 HECM LINE OF CREDIT STRATEGY In the HECM Line of Credit Strategy, our client simply nets $200,000 from the transaction of selling their old home and purchasing the new home. Their portfolio is now $700,000. The couple then establishes a line of credit which would have an initial value of $157,000. The maximum closing costs of $7,000 are assumed to be paid by the portfolio to maximize the available line of credit. The line of credit was assumed to be left to grow over time, and was only used if the portfolio depleted. In this case, the line of credit was used to fund the couple?s standard of living. In this strategy, 75% of the trials resulted in the portfolio being exhausted by age 90, like our paying cash scenario above. However, because the line of credit was available to use to continue meeting living expenses, the ability for our client to fund their goals using all their resources (portfolio plus line of credit) was over 95%. Probability Median Portfolio Median Net Worth 95% $600,000 $1,200,

8 CONCLUSIONS As we evaluate strategies for purchasing a new home in retirement it is apparent, from the above analysis and from past research, proactively incorporating home equity is important and yields better results for maintaining a standard of living over time. When resources are very limited, the HECM for Purchase may be not only the best option, but an option which will allow the purchase of a new home and also may free some home equity to be used for future living, healthcare, and other expenses. When evaluating the choice between the HECM for Purchase and HECM Line of Credit option for those with more options, the decision to be either goals-focused (probability of meeting goals) or resource-focused (probability of having more later) must be weighed. This case analysis, as with previous research by Wade Pfau in his Journal of Financial Planning article,?incorporating Home Equity into a Retirement Income Strategy,? demonstrates this point. The early use of proceeds, such as the HECM for Purchase, may decrease the probability of meeting goals, but may provide the possibility of having more later to satisfy long-term goals such as bequest motives. Those strategies deferring the use of the HECM proceeds, such as the line of credit, improve the probability of meeting goals, but at times can drastically reduce what may be available in the future. The reasoning for the difference in probability and future resources can be summed by two points: - Using the growth in the HECM Line of Credit later requires the use of the portfolio to fill the near-term spending needs; this compares to the HECM for Purchase essentially pulling from the HECM available funds first. In the Line of Credit strategy, portfolio assets are used before using any HECM proceeds, so the portfolio value is less to begin with, and will be less over time. - The probability of success is higher with the HECM Line of Credit strategy because, between the line of credit and the portfolio, the line of credit has a better risk-adjusted return on its resource compared to the portfolio. Essentially, the portfolio?s growth in the future is riskier than the line of credit. The risk of the line of credit growth rate 1) is only related to the variation in the one-month LIBOR, and 2) historically has not been negative. Portfolio assets, though, grow at a higher rate, have a higher risk and have certainly historically been negative. A very general conclusion, though individual analysis cannot be emphasized enough, is that those who are goal-focused may be better off seeking a HECM Line of Credit Strategy, and those who are resource-focused, or looking to have more later, might seek a HECM for Purchase option. This analysis examined the impact of down-sizing, one additional consideration to note is taxes when up-sizing. To enter a HECM Line of Credit strategy, the home must be first paid for. Should a large distribution from assets be needed that would trigger a high tax burden, the HECM for Purchase may result in a better option to avoid paying the higher up-front tax. 8

9 This educational content was sponsored by and is compliments of: Reverse Mortgage Funding LLC and Retirement Experts Network For more information, please visit us at: retirementexpertsnetwork.com or call Retirement Experts Network is an educational platform for financial professionals brought to you by Reverse Mortgage Funding LLC, a reverse mortgage lender. This material has not been reviewed, approved or issued by HUD, FHA or any government agency. The company is not affiliated with or acting on behalf of or at the direction of HUD/FHA or any other government agency. Reverse Mortgage Funding LLC makes no warranties concerning the accuracy or completeness of any of the information contained in these materials, and the content does not necessarily reflect the official policy or position of RMF Reverse Mortgage Funding LLC, 1455 Broad Street, 2nd Floor, Bloomfield, NJ 07003, Company NMLS ID: # ( Arizona Mortgage Banker License # ; Licensed by the Department of Business Oversight under the California Residential Mortgage Lending Act; Loans made or arranged pursuant to a California Finance Lenders Law; Georgia Mortgage Lender Licensee #36793; Illinois Residential Mortgage Licensee; Massachusetts Mortgage Lender License #ML ; Licensed by the New Jersey Department of Banking & Insurance; Rhode Island Licensed Lender; Texas Mortgage Banker Registration in-state branch address 6044 Gateway East, Suite 236, El Paso, TX Not intended for Hawaii and New York consumers. Not all products and options are available in all states. Terms subject to change without notice. Certain conditions and fees apply. This is not a loan commitment. All loans subject to approval. L986-Exp042018