Originating Reverse Mortgages: Purchase-Money Transactions

The following is an excerpt from Chapter 15 of Volume I of The Mortgage Professional's Handbook:


John Button, President and CEO

Congress authorized HECM (Home Equity Conversion Mortgage) for Purchase in 2008, and HUD had the program up and running in 2009. When, in November, 2013, Texas passed Proposition 5, a state constitutional amendment allowing the origination of HECM for Purchase loans there, it joined the other 49 states, Washington D.C., and Puerto Rico that have acknowledged its usefulness.

According to HUD, HECM for Purchase allows seniors, age 62 or older, to purchase a new principal residence using loan proceeds from the reverse mortgage. The program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction. The program was also designed to enable senior homeowners to relocate to other geographical areas to be closer to family members or downsize to homes that meet their physical needs, i.e., handrails, one level properties, ramps, wider doorways, etc.

HECM for Purchase Helps Baby Boomers Extend Retirement Resources
As expected lifespans increase beyond eight decades, many in the Baby Boomer generation are eager for legitimate options to help stretch their retirement assets to daunting 20 or 30-year horizons. The HECM for Purchase can be a great financial strategy tool for significantly extending retirement resources.

Consider a scenario in which a couple is contemplating near-term retirement. What can they accomplish toward securing their retirement finances by downsizing right now? They can apply some of the funds from the sale of the departure home to create an investment fund, then combine this with a HECM for Purchase on a retirement home to secure additional peace-of-mind liquidity and eliminate the burden of monthly mortgage payments.

Here’s how that might look: Assume the couple, at ages 65 and 62, sell their home, now worth $200,000, which they own free and clear and that it costs them $14,000 to sell the home (include commissions to realtors, escrow, closing costs), netting $186,000. That’s a useful chunk of funds, but they still need a home. Let’s assume this couple downsizes into an energy-efficient property that meets their needs and lifestyle changes, and say that property has a $150,000 purchase price.

With the HECM for Purchase, depending on the age of the youngest borrower and their expected lifespan, they’ll receive a percentage of that value as available funds to use toward the purchase price of that home. Since they’re on the younger side, they will qualify for about 52.6 percent, or about $78,900, less $7,100 financed cost of the loan, generating $71,800 in reverse mortgage funds that can be applied toward the purchase price of the home.

Here’s how the scenario plays out. An attractive scenario would be to use a portion of the $186,000 net proceeds above to cover the remaining $67,500 of the purchase price for the downsized home ($71,800 (HECM funds) + $78,200 (net proceeds) = $150,000). Now, this couple has $107,800 remaining to help fund their retirement. The result of this HECM for Purchase transaction is that our couple downsizes into home on which they never have to make a payment, and secures appreciable funds for retirement finance.

Now let’s look at the options available for structuring the HECM. Some loan originators might put this couple into a fixed-rate HECM and some borrowers might feel safer with a fixed rate. However, another fascinating piece to this financial strategy is that, if they took an adjustable rate reverse mortgage, instead of a fixed rate, they could make regular or occasional payments, with the net effect of building available funds.

Here’s how that would work. Assume this “young” couple is still working and wants to make an occasional $1,000 payment on their HECM. That money will not simply reduce the balance on the reverse mortgage, but more important, with the adjustable rate mortgage that $1,000 becomes available in a line of credit similar to the HELOC. Borrowers can draw it out and can pay it back as many times as they like. Moreover, the HECM line of credit has a growth rate.

The growth rate is the initial interest rate plus the lender’s margin, plus the ongoing mortgage insurance premium that goes to FHA. The growth factor on this example might be as much as 4.196 percent annually (as of Q3 2015), and continues to compound. In this way, the HECM for Purchase can also help the borrower create another bucket of funds for retirement, allowing homeowners to leverage their home as a financial planning tool with a holistic and more realistic view of retirement.

Specifically, for a Baby Boomer planning to downsize, a forward mortgage is the riskier choice. By securing a HECM prior to the onset of possible health issues, in this scenario the couple has hedged against foreclosure or a loss of the home due to an inability to make their mortgage payment.

With the HECM for Purchase line of credit option, this couple is hedging against foreclosure with a payment-optional mortgage, and any payments that are made become available with compounded interest to them later.

Mortgage lenders have no better tool available to meet the needs of home buyers age 62 and older. Those home buyers that use a HECM for Purchase have secured unparalleled peace of mind and protection for their heirs.

Retirement Dream Home with HECM for Purchase
Another aspect of how the HECM for Purchase product can help is the intriguing scenario for the borrower that wants to purchase a retirement dream home, and create a nest egg, without adding a required payment to their monthly budget. Again, this safe, versatile, and multi-dimensional home equity product can be ideal.

In the previous example, a couple sold their home, valued at $200,000, from which they net $186,000 in cash. By combining funds from a HECM for Purchase reverse mortgage with the funds that they realized from their departure home sale, they can upsize into their dream retirement home.

Our example couple could buy a $275,000 home and still have no house payments. That’s a 35 percent more expensive retirement home for a borrower who is 62, but if they were older they would qualify for even more HECM for Purchase money. In this example, calculating based on the younger borrower produces a conservative result.

In this upsizing scenario, when using an adjustable rate HECM product with line of credit, should the borrower elect to make some payments they would be rewarded with an increased line of credit balance, which would enjoy the same growth rate as in the previous example.

For mortgage lenders, the point is that HECM for Purchase is versatile and yet it’s one of the most underutilized products available to serve the 62 and over demographic. It can be a complicated loan, so borrowers need a loan officer who understands how to structure it. Lenders need to be familiar with the HECM for Purchase product specifically, even if they have worked with HECM before. They need to be able to evaluate and explain this loan’s performance as a financial strategy tool. In fact, lenders would benefit by seeking to partner with financial planners. As a team, professionals can work together to help boomers stretch retirement resources for 30 years with peace of mind.

Even well-to-do folks will look to the reverse mortgage for purchase when they recognized the opportunity to leave their own funds invested and use this government insured loan to finance part of a new home.

Also, used this way, the HECM for Purchase can play a role in managing retirement finances when the stock market is down, since dollar cost averaging can be a killer for retirement funds. In that scenario, chances are retirees would have to take out twice as much stock every month to meet their monthly retirement budget, expiring their asset portfolio twice as fast as they had planned

In planning for this possibility, homeowners with the HECM for Purchase line of credit option can pay into it when the market is performing well for their invested assets, letting it build in value. When there’s a downward stock market fluctuation, instead of selling off stock, their financial planner can instruct them to take money out of their HECM line of credit to cover what they need and leave their stock market portfolio alone.

When the stock market comes back up, their portfolio is whole, so they’re much further ahead financially. Then, they can start to sell that stock and they can even sell enough to pay back what they’ve taken out in the reverse mortgage line of credit, setting themselves up to maintain that resource.

They just have to leave $100 in the line of credit, so that the lender doesn’t close the loan. Everything above that continues to build and grow in value. When the stock market is down these HECM borrowers don’t sell stock, they use their HECM line of credit. When the stock market goes back up they sell some stock and pay back the line of credit.

This strategy for leveraging the HECM reverse mortgage as part of a financial strategy has been explained effectively in a 2012 paper authored by Texas Tech University professors John Salter, Ph.D., CFP®, AIFA®; Shaun Pfeiffer, and Harold Evensky, CFP®, AIF® , which can be found at the Journal Of Financial Planning website:
In that paper, they found that by establishing what they called “a standby reverse mortgage,” on average retirement funds can stretch an additional dozen years relative to an approach using only a stock market portfolio.[JB1] 

So, whether the HECM for Purchase is for downsizing or upsizing a retirement home purchase, the HECM adjustable rate line of credit is a powerhouse strategy to buttress and extend retirees’ financial resources. That’s a loan product bound for broader demand as the Baby Boom Generation marches toward its golden years.

 [JB1]Not specific to H4P. Move to more appropriate place.

Read the rest of this chapter, and two other chapters on reverse mortgages, in The Mortgage Professional's Handbook!

John Button, President & CEO of ReverseVision, is a business-to-business executive, investor and entrepreneur with more than 30 years’ diverse experience concentrated in technology and the cultivation of business development strategies. Before joining ReverseVision as president, John had been focused on a series of business ventures including serving as president of an information sharing technology provider, an investor in two businesses and a consultant to a business incubator.

Previously, John served as Chief Operating Officer for Del Mar DataTrac (DMD) – a leading innovator in mortgage lending automation, including the well-regarded mortgage loan origination system (LOS) DataTrac. His role with DMD included overall business operations responsibility, direct responsibility for product management, customer support, professional services and information technology. Prior to that, John has held senior executive positions with IPS Sendero, RF/Spectrum Decision Science Corporation, and IBM.

John was an employee of the U.S. Navy, where he served as a systems engineer and attended both Drexel University and Rensselaer Polytechnic Institute. He is a motorcycle enthusiast and enjoys going on rides in Baja and the US as often as possible.