By Jeff Brown
Is this a good time to get a reverse mortgage? Yes -- even if you don't need one. That's the recommendation from Jack M. Guttentag, an emeritus finance professor at The Wharton School at the University of Pennsylvania. On his website, The Mortgage Professor, he says homeowners old enough to have a reverse mortgage -- 62 or older -- should think about getting a reverse mortgage credit line now, even if they won't use the money for years. Reason: Today's low interest rates make reverse mortgages something of a bargain, allowing you to borrow more if you lock in before rates rise.
A reverse mortgage is a loan against the homeowner's equity, which is the current value of the home minus any debt against it, such as a mortgage or home equity loan. Like an ordinary mortgage, the reverse loan charges interest, but the borrower makes no monthly payments. Instead, the debt, plus the gradually growing interest charges, are paid off when the borrower moves permanently, sells the home or dies.
The debt can never exceed the proceeds of the home sale, so the reverse mortgage debt does not endanger the borrower's other assets. The most common type of reverse mortgage is the federally backed Home Equity Conversion Mortgage. Because there's no telling how large the borrower's debt could grow, reverse loans manage the lender's risk by providing less than 100 percent of the homeowner's equity at the time the loan is approved. A key factor in this calculation is the "expected interest rate." The lower it is, the more the homeowner can borrow, and rates are quite low today.
"For example, at an expected rate of 4 percent, which has been a common rate during 2013, a senior of 62 with a home worth $300,000 can draw an initial credit line of about $174,000," Guttentag says. "At an expected rate of 6 percent, the line drops to $140,000, and at 10 percent it falls to $54,000." In other words, get a reverse mortgage now and you can borrow more than if you wait until rates rise, as most experts expect over the next few years.
But wait, there's more -- a second interest rate called the "accrual rate." Like the interest rate on a regular mortgage, it is the rate charged against the loan balance. If you use the reverse mortgage to borrow a lump sum, it is a fixed rate for the life of the loan. If you take out a line of credit to draw on in the future, or select a regular monthly payment, the accrual rate is adjustable -- it will rise or fall as market conditions change.
A rising rate need not be a concern if you expect to keep the reverse mortgage for the rest of your life, because you don't have to make payments no matter how high the rate goes. (Of course, a higher rate would drive up your interest costs, cutting deeper into any home equity you might hope to leave your heirs.)
But the accrual rate has another function. Over time, the home presumably becomes more valuable, and therefore any unused portion of the borrower's credit line grows as the years go by. The accrual rate is used to determine how fast the credit line grows. The higher the rate, the bigger the credit line.
That means the homeowner who does not need to take cash out of the home right now can use today's low expected interest rate to get the largest possible line of credit to start with, and then, if the accrual rate goes up as expected, the borrower will see the credit line grow. The ideal strategy, Guttentag says, is to hold off drawing against the credit line for as long as possible. That way you could remain free of debt, but would have a rainy day fund that could be much larger by the time you need it.
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