Reverse Mortgage Before It’s Needed

Why Open A Reverse Mortgage Before It’s Needed?

 I have been preaching this sermon for years and some financial planners have started to listen. Open the Reverse Mortgage early in life and let the line of credit grow.
The Elder Care publication (NAELA) wrote a front page article last spring call Long Term Care Insurance or Reverse Mortgage??

Would the line of credit ultimately be larger if opened earlier rather than later? We can further explore this question with a more realistic example. Exhibit 1.1 below provides an illustration of the impact of opening a reverse mortgage at different points in time using a few basic assumptions.

For more information, download our Reverse Mortgage 101 Cheatsheet. 

Still keeping matters relatively simple, I assume that the one-month LIBOR rate stays permanently at 1.25 percent and the ten-year LIBOR swap rate remains permanently at 2.25 percent. The lender’s margin is assumed to be 2.75 percent, and home inflation is 2 percent.

 For a sixty-two-year-old with a home worth $250,000 today, the exhibit charts three values over time until the individual is ninety. The home value grows by 2 percent annually, and it is worth $435,256 by age ninety. The principal limit for a reverse mortgage opened at sixty-two is $102,500 (based on a principal limit factor of 41 percent for the 5 percent expected rate. The principal limit grows at an effective rate of 4.5 percent, and the principal limit is worth $351,544 by age ninety.

Finally, Exhibit 1.1 also shows the available principal limit if the reverse mortgage is not opened until each subsequent age rather than at age sixty-two. By delaying the start of the reverse mortgage, and assuming that the expected rate of 5 percent remains, the principal limit grows because the principal limit factor is higher at advanced ages, and because this factor is applied to a higher home value.

Nonetheless, even at age ninety, the available principal limit for a new reverse mortgage is only $284,222, which is based on a PLF of 65.3 percent applied to a current home value of $435,256. The message from this example is that opening the line of credit earlier allows for greater availability of future credit relative to waiting until later in retirement.

Exhibit 1.1: Comparing Principal Limits Based on When the Reverse Mortgage Opens

Comparing Principal Limits Based on When the Reverse Mortgage OpensRETIREMENT RESEARCHER

Admittedly, Exhibit 1.1 does look less impressive in terms of the potential value of opening the reverse mortgage early compared to the same exhibit from the first edition, before the October 2017 rule changes. Exhibit 1.2 compares the growth in the principal limit for loans from before and after the October 2, 2017, change in program parameters. Under the old rules, the principal limit could grow more rapidly, as it started from a higher initial base and included an ongoing mortgage insurance-premium of 1.25 percent in the effective rate instead of the current 0.5 percent. By age eighty-three, the principal limit exceeded the value of the home—twenty-one years after the loan was initiated. More broadly, Exhibit 1.2 shows how the pace of principal limit growth was substantially slowed by the October 2017 rule change.

Exhibit 1.2: Comparing Principal Limit Growth Beginning at Age 62 for HECMs before and after October 2017

Comparing Principal Limit Growth Beginning at Age 62 for HECMs before and after October 2017RETIREMENT RESEARCHER

This example assumes that interest rates remain low. But if interest rates increase in the future, the value of opening the line of credit today would be greater. Rising future interest rates would help to bring back some of the excitement about line-of-credit growth that was tempered by the October 2017 rule updates. With lower rates today, the available PLF is higher. Then, higher future interest rates would cause the future effective rate to be higher so that the principal limit grows more quickly. Rising rates would also increase the expected rate used to calculate principal limits on new reverse mortgages in the future. This would reduce the principal limit on newly issued future loans. An example of this is provided in Exhibit 1.3. The scenario is the same as in Exhibit 1.1, except that later in the first year of analysis, interest rates permanently increase by 1 percent, which raises the effective rate to 6 percent for HECMs issued at later ages and the effective rate for principal limit growth to 5.5 percent. The exhibit shows the widening gap in available principal limit created by opening the reverse mortgage sooner. If interest rates rise in the future, the case for opening the reverse mortgage sooner than it is potentially needed becomes stronger.

Exhibit 1.3: Comparing Principal Limits Based on When the Reverse Mortgage Opens, Assuming that Interest Rates Permanently Increase by Age 63

Comparing Principal Limits Based on When the Reverse Mortgage Opens, Assuming that Interest Rates Permanently Increase by Age 63RETIREMENT RESEARCHER