Maximize your borrowing power on a HECM loan

Editor’s note: This is the second in a multipart series. Read Part 1.

The first article in this series looked at the various reasons many Home Equity Conversion Mortgage (HECM) borrowers make bad choices. One important reason is that they don’t fully understand the longer-run consequences of the various HECM options that are available. That is the subject of this article.

The senior’s borrowing power

The different HECM payment options can be viewed as different ways that seniors can use the borrowing power of their homes. Total borrowing power depends on the property value, the age of the youngest co-borrower, and the expected interest rate and upfront fees on the HECM. The senior can use her borrowing power to withdraw cash, purchase an annuity, reserve a credit line that grows larger as long as it is not used, or some combination of the three.

Using all borrowing power upfront

Table 1 shows the maximum amounts that a 72-year-old with a $400,000 house can draw using her full borrowing power for each of the options. She can withdraw cash of $257,000, purchase a tenure annuity that pays $1,433 a month so long as she lives in the house, or purchase a term annuity for a shorter period, such as the five-, 10- and 15-year periods shown in the table.

The different options have different implications for the growth of mortgage debt. All the options result in the same debt when the borrower reaches age 100, but prior to that longer annuity periods result in smaller debt growth.

For example, after five years, the debt of the senior who took the largest possible tenure annuity is only one-third as large as the senior who withdrew the maximum amount of cash. This means that if the borrower dies early, her estate is substantially larger if she had taken the tenure annuity. Further, assuming she lives on, she can convert her lower debt in the early years into additional borrowing power by modifying her program, a point discussed below.

Table 1. HECM Maximum Payment Options and Future Debt of a Senior of 72 With House Valued at $400,000, Using a Standard ARM

HECM Maximum Payment Options	Loan Balance
	At Closing	After 5 Years	After 10 Years	After 15 Years	After 28 Years
Upfront Cash of $257,000	$271K	$349K	$451K	$582K	$1.129 million
Monthly Payment of $4,839 for 5 Years	$14K	$349K	$451K	$582K	$1.129 million
Monthly Payment of $2,726 for 10 Years	$14K	$205K	$451K	$582K	$1.129 million
Monthly Payment of $2,037 for 15 Years	$14K	$158K	$343K	$582K	$1.129 million
Monthly Tenure Payment of $1,433	$14K	$116K	$248K	$418K	$1.129 million

Note: Payment amounts are based on an expected interest rate of 3.86 percent plus a mortgage insurance premium of 1.25 percent; debt and unused credit line are calculated at the current ARM rate of 2.497 percent plus 1.25 percent; financed closing costs are $14,000. Data are as of July 28, 2012.

Reserving borrowing power

Seniors who elect to take less than the maximum of whatever option they select reserve the remainder of their borrowing power for future use. This is illustrated in Table 2 below, which applies to the same senior as Table 1 but assumes that only about half of her borrowing power is used upfront. That reserves a credit line of $128,000, which, if not drawn on, grows larger each year.

Table 2. Credit Lines and Future Debt For a Senior of 72 With House Valued at $400,000, When Senior Draws Half of Maximum Cash, 5-Year and Tenure Options

Half of HECM Maximum Payment Options	Loan Balance/Credit Line
	At Closing	After 5 Years	After 10 Years	After 15 Years	After 28 Years
Upfront Cash of $129,000	$143K/ $128K	$184K/ $166K	$237K/ $212K	$305K/ $273K	$590K/ $527K
Monthly Payment of $2,420 for 5 Years	$14K/ $128K	$184K/ $166K	$237K/ $214K	$306K/ $276K	$594K/ $535K
Monthly Tenure Payment of $716	$14K/ $128K	$67K/ $166K	$136K/ $214K	$224K/ $276K	$593K/ $535K

Program modifications

The senior who takes out a HECM is free to switch to another option at any time for a fee of $20. For example, the borrower who draws less than the maximum cash at the outset could draw a tenure annuity at any point based on her unused credit line and age at that point. In some cases, furthermore, seniors can advantageously modify the terms of an existing option, even when they have no unused credit under that option.

For example, the senior in Table 1 who drew the maximum tenure annuity could convert to a new tenure annuity at the end of five years that would raise the payment from $1,433 to about $1,566. Program modifications are a powerful but little understood feature of the HECM program.

The wise path for seniors taking a HECM is to draw as little as possible at the outset, preserving maximum freedom of action for the future. This applies particularly to baby boomers just reaching eligibility at 62.