HUD fails to mention a clear-cut and, to me, far safer way, at least for older people, to tap home equity.
Are you 62 or over, house poor and barely making ends meet? If so, the Department of Housing and Urban Development (HUD) claims to have the answer. It’s called a Home Equity Conversion Mortgage, or HECM. HUD regulates HECMs, or at least it says it does.
An HECM sounds like a great financial product. It lets people 62 and older, many with little if any financial assets, tap into their home equity to get either immediate or monthly cash payments to help pay bills. In exchange, the household (let’s call them the Smiths) signs an IOU (the HECM) with the financial company (let’s call it ABC Corp.) issuing the HECM.
But the HECM mortgage is not like a standard mortgage. It’s seemingly “free.” No borrowed money is repaid until the Smiths leave their home, whether vertically or horizontally. But here’s the rub: Because the mortgage is not being repaid, all the interest owed as well as five different fees are added to the mortgage balance. Consequently, the outstanding balance rises rapidly through time.
When the Smiths leave their home, ABC will either take the entire house (if the mortgage balance exceeds the house’s value) or it will sell the house, pay itself the mortgage balance and leave the rest to the Smiths. Consequently, the Smiths or their heirs may receive nothing or very little from the sale of the house.
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If the Smiths die at home and have no heirs, then they got money, got to live in their house until the end.
But if they die with heirs or if they need to move to a nursing home or near their children, the Smiths’ share of the proceeds from their house’s sale becomes a big deal. This share can be quite small, for many reasons.
First, the mortgage interest rate is higher, potentially far higher, than conventional mortgages. Second, many of the HECM mortgage rates are adjustable. These already high rates can rise dramatically, while the cash paid the Smiths doesn’t change. Third, the HECMs come with five different fees, some huge.
But these potentially high rates and huge fees don’t cost the Smiths anything until their exit day. As a result, they may pay little attention to what will be owed. If the Smiths are 62, have a $300,000 house and borrow $100,000 at a 6 percent rate on their HECM, they will owe $320,000 20 years later. If they have to move, they’ll get nothing from the sale of their home.
HUD has a website that provides — in my opinion, highly confusing and limited — information about HECMs. HUD also requires HECM borrowers to go through a counseling session. There, potential customers doubtless have their heads spun with talk of adjustable “Libor rates,” “annual insurance premiums” plus the various fees. These fees include an extra initial insurance premium that can equal a whopping 2.5 percent of what’s borrowed. This effectively raises the annual interest rate 2.5 percentage points. Then there is an “origination fee” that totals anywhere from $2,500 to $6,000.
HUD’s website doesn’t whisper, let alone scream, “RISK,” but an HECM comes with a huge, undisclosed risk of the Smiths having to move or dying and they or their heirs losing a good chunk — if not all — of their home to ABC. And, after blessing the HECM as a seemingly safe way to rescue trapped home equity, HUD lets lenders, to a large degree, set their own terms. Given the HECM’s complexity, this is fraught with danger to consumers who can easily miss the fine print.
Third, HUD fails to mention a clear-cut and, to me, far safer way, at least for older people, to tap home equity. This entails taking out a long-term fixed mortgage on your home and using the proceeds to purchase a fixed annuity payment. Assuming the fixed annuity payment exceeds the fixed mortgage repayment, which it will if you’re old enough, there will be money left over for the household to spend.
Yes, annuities leave no money to heirs, and their issuers need to be around as long as you’re around. But you can make gifts to heirs through time and buy annuities from multiple insurers to hedge insurer risk. This home-rolled reverse mortgage seems far cheaper and safer than a HECM. Based on prevailing mortgage and annuity rates, a 75-year-old single male should be able to net over $9,000 a year on a $300,000 mortgage. A 75-year-old married couple would want to buy a joint (last-to-die) annuity, but then would only net about $4,500 a year.
No, they won’t get nearly as much immediate “free” money. But they won’t get ripped off.