Does it Make Sense to Take a HECM Reverse Mortgage on a Million Dollar Home?

August 3, 2017, revised August 22, 2017, reviewed January 22, 2021

Note: The maximum FHA claim amount in 2021 was $822,375, which raises the estate values that are shown below. I have not bothered to recalculate the estate values, however, because the maximum is adjusted every year and does not affect the logic or the conclusions.

The maximum amounts that can be drawn on a HECM are based on the lower of appraised value, sale price and the FHA maximum claim amount, which currently is $636,150. The owner of a million dollar house, or a $10 million dollar house, can’t draw any more funds from a HECM than the owner of a house worth $636,150.

If the house securing a HECM reverse mortgage is worth more than the FHA maximum, the borrower is in effect posting excess collateral, reducing the risk of loss to FHA but without reducing the insurance premium paid to FHA. Here is an example. Jones and Smith, both 62, have houses worth $636,150 and $1 million, respectively. Both obtain the maximum monthly tenure payment of $1854, and both remain alive and well in their homes until they reach age 100. At that point, assuming unchanged interest rates, both will owe about $2,750,000. If both houses appreciate by 4% a year, which is the assumption used by HUD in calculating draw amounts, Jones’ heirs will receive about $70,000 while Smiths’ heirs will receive about $1.7 million. The excess collateral posted by Smith 38 years earlier grows into a nice windfall for Smith’s heirs.

Now consider the case where things don’t go as planned – the houses appreciate by only 3% a year instead of 4%. In that case, Jones’ house value does not cover the HECM loan balance and FHA must absorb an $800,000 loss. In Smith’s case, however, because of the excess collateral at the outset, there is enough equity to cover the loan balance, even with 3% appreciation. The heirs now get only about $320,000. Smith’s excess collateral has protected FHA at the expense of Smith’s heirs.

That doesn't mean that having a home worth more than the FHA maximum claim amount is a good reason to avoid taking a HECM reverse mortgage. Given the alternatives, the HCM may be the  best option. The alternative to posting excess collateral on a HECM is to take a jumbo reverse mortgage, which is not subject to a legal maximum claim amount. However, jumbos are currently available only in 13 states and are fixed-rate only. Because there are no adjustable rate jumbos, owners can draw cash only at closing. There are no monthly payment options or credit lines. The rate on jumbos right now is 7.75% as compared to HECM fixed rates of 4.0-5.1%, though this sizeable difference is partly offset by the absence of mortgage insurance premiums on jumbos.

Jumbos are for owners of high-value homes who want to extract more equity from them upfront than is possible with a HECM, possibly to pay off a large existing loan balance. For example, a borrower who owes $1 million on a $5 million home can pay it off with a jumbo if the property is in California, Florida or 11 other states, but there is no way to pay it off with a HECM.

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