FHA insured reverse mortgages, called HECMs, allow seniors to withdraw cash from their home while retaining the right to live there indefinitely. They are a potentially powerful tool for helping seniors live better lives during their retirement years, and new HECM options enlarge the possibilities.  

However, the benefits can also be frittered away, with little lasting benefit to the senior, and all too many seniors are doing just that. When this articlde was first written,  about 2/3 of all HECM borrowers were withdrawing the maximum amount of cash possible at closing, which left the senior with no borrowing power for the future. While some seniors have compelling reasons for withdrawing the maximum amount of cash at the outset, many were making a mistake.  

Late in 2013, HUD changed the rules to limit upfront cash draws, because they viewed cash-draw HECMs as a source of loss to the insurance reserve fund.   

HECMs Are Complicated

Underlying the mistakes that seniors make is the complexity of HECMs and the fact that few seniors understand them. The new options increase the complexity. While there is no way to make HECMs simpler, or to raise the IQs of senior borrowers,  the likelihood of bad decisions can be reduced by improving the quality of advice that they receive, and the quality of the information to which they have access. 

The Role of Counselors 

Every HECM borrower must be counseled by a HUD-approved HECM counselor, but counselors are not preventing borrowers from making serious mistakes. Even if counselors were financial planners qualified to advise seniors on how a HECM fits into a retirement plan, which most are not, under HUD rules, counselors are not supposed to recommend one HECM option over another. Many HECM borrowers, furthermore, turn off their hearing aids during their counseling session.  

But perhaps the most serious deficiency in the counseling process is that it does not occur until the borrower has contacted a loan provider, which in most cases indicates that they are committed to taking a HECM, even if the details are not yet finalized. Many, perhaps most, have pressing and immediate financial problems. Their numbers are small relative to the millions of seniors who do not have pressing problems, but whose lives might nonetheless be improved with a HECM.  

This much larger group of seniors are not aware of what a HECM might do for them, their information is likely to be limited to what they have heard in advertisements or solicitations, to which they understandably react with caution and suspicion. While there are places they can go to obtain unbiased information , including this site, most are not aware of such resources, many don’t use the internet, and they are not being driven by financial need to take any action. They represent a potential market of enormous size that is not being served. 

Lender Incentives 

HUD limits the origination fees that borrowers can be charged to 2% of the first $200,000 of property value, plus 1% of the amount above $200,000 but with a cap of $6,000. In addition, lenders collect a yield-spread premium paid by the wholesalers to whom they sell the HECMs. On the day in July that I checked, these premiums were 7.625% on fixed-rate standard HECMs, and 4.875% on standard adjustable rate HECMs. Premiums are paid on the initial loan balance only. 

Thus, a senior of 72 with a $400,000 home will generate premium income for the lender amounting to $20,600 if he draws maximum cash on a fixed-rate mortgage; $13, 200 if he draws maximum cash on an adjustable-rate mortgage; and $600 if he elects an annuity on an ARM. In the last case, the initial loan upon which the premium is based consists only of the financed settlement costs. The bottom line is that lenders have a strong incentive to encourage borrowers to withdraw cash upfront. Unfortunately, in many cases, borrowers don’t need much if any encouragement. 

Borrower Bias Against ARMs 

Most senior homeowners had one or more forward mortgages during their life, from which experience many emerged with a bias against ARMs. They may not have had one, but they heard about them and knew that they were risky. So when offered a choice of fixed or adjustable rate HECMs, they opt for the fixed, which requires that the full value of the HECM be taken in cash.  

Borrower bias against ARMs combined with lender financial interest in maximum cash withdrawals make for a perfect marriage. But not one made in heaven.  

Borrower bias against HECM ARMs is misconceived. On forward mortgages, borrowers are exposed to the risk that a future interest rate increase will make the monthly payment unaffordable, but there is no such risk on a HECM because borrowers have no mortgage payment to make.  

A future increase in the rate on a HECM does result in a more rapid increase in the senior’s loan balance, but this only hurts borrowers who use all or most of their borrowing power by drawing cash at the outset. To the extent that the senior reserves some part of his HECM borrowing power as an unused credit line, future ARM rate increases work to his benefit because the line grows at that rate.  

The upshot is that seniors with needs best met by an annuity payment, and/or by husbanding a credit line for future use – which is most of them -- should not shrink from taking an ARM.  

Information Available to Borrowers 

While HECMs are complicated, we live in an information age replete with sophisticated tools for expositing complicated ideas. Lucid exposition of the full implications of each possible course of action can overcome a borrower’s preconceived bias and the entreaties of interested loan originators.  

The tools available to HECM borrowers, however, are a sorry lot. The existing calculators focus entirely on how much the borrower can draw, without any supporting information on the future consequences of a given selection. So I decided to develop my own. See Calculate Your HECM Reverse Mortgage Options.