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Low Interest Rates hurt Savers but Help Reverse Mortgage Borrowers
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Why bad news for savers is good news for potential reverse mortgage borrowers. It’s a catch 22 for many retirees. As the Federal Reserve sought to boost the economy lowering interest rates their interest on savings slowed substantially. These retirees will begin to consume the principal more quickly as interest earned dwindles.The Boston Center for Retirement Research says there is a sliver lining.
With HUD’s lowering of the expected rate from 5.5% to 5.0% in 2010 we have smaller window of opportunity for borrowers who may choose to wait.
2 Comments
Newton’s third law of motion states: “For every action there is an equal and opposite reaction.” This is true in the HECM World as well. While low note rates may help increase the available cash inflow from a higher principal limit, they also impede the “growth” of the line of credit and thus available cash inflow to existing borrowers.
Also there is an old myth in the industry that somehow by getting a HECM now versus later, seniors can permanently save the entire monthly mortgage payment outflows of principal and interest they would otherwise be forced to pay. While that is true of interest (net any income tax benefit), it is only temporarily true for the principal portion of the payment.
For example, assume payments are $900 a month and the loan is $100,000. Let us say the borrower is looking to do the HECM now or two years from now.
In Scenario 1, let us say the borrower has a special county loan where there is no interest unless the borrower either payoffs the loan before or does not live in the home for at least five years; the senior has lived in the home for exactly three years. So at the time the borrower gets the HECM in two years the amount owed is only $78,400 (or $100,00 – $21,600). So if the senior gets the HECM now, $100,000 of the principal limit would have to be used to payoff the existing while if the senior waited two years there would only be $78,400 and the senior would not have incurred interest on $21,600 during that two year period.
On the other hand, in Scenario 2 the mortgage payment is interest only and the rate is fixed for the two year waiting period. In this case the balance due on the existing mortgage does not change so the HECM principal limit would have to pay off $100,000 on the existing mortgage both now and later. Thus all of the cash paid on interest (net of income tax benefits) in the two year period is lost.
So the general rule is the principal portion of monthly mortgage payments may be recoverable through the HECM but not interest. But the potential cash flow losses to those who wait are 1) a lower principal limit, 2) a lower home value, 3) a lowering of the lending limit from $625,500, 4) the growth of any available line of credit during the waiting period, and 5) permanently lost cash flow from interest (and any other costs) paid on an existing forward mortgage.
(The opinions expressed are not necessarily those of RMS or its affiliates.).
Waiting is not a good option for most potential HECM borrowers. Taking out a LOC now is likely to leverage the borrowable equity far greater than gains produced by increase in borrower’s age and property value. Especially given the effects of rising Swap Rates on PLF and the diminished flexibility of the product that is certainly coming in the near future.
Yes, there are any number of scenarios that might suggest waiting is prudent, but I am willing to say, not for most.
Here’s my rule for HECM borrowers – Take the bird hand.