How Do Property Values Affect Potential Reverse Mortgage Users?

To better understand how a factor like property value affects a reverse mortgage, it’s helpful to zoom out to see everything that goes into it first.? Unlike forward/conventional mortgages that are sometimes leveraged up to 100% of the home value, a reverse mortgage only allows borrowers to access a portion of already earned equity typically around 40-50% to start.? Also unlike a forward mortgage, you can never get underwater with a reverse mortgage no matter how high the balance got over time, because borrowers are never required to repay more than the house is ever worth at any given time!? It transfers the risk of future housing values to the lender!? Yet still allows for the borrower to own the home and sell whenever they want walking with whatever equity is there if they ever want to move.?

*That is the concept financial planners can understand better than most because of their mastery of the time value of money.? In other words, someone can minimize or cap their lifetime housing cost (even if they had already prepaid it by paying off the house) and still take back out some of the appreciation they’ve earned and money dumped into it previously.

The amount of equity that someone has access to, also called the Principal Limit, is determined by 3 general factors:?

1. Age of the youngest borrower or non-borrowing spouse?
2. Interest rates (10-yr treasury)
3. Appraised value

Age. The age of the borrower affects the Principal Limit (amount available) intuitively because the lender and insurer (FHA) use it to estimate lifespans of borrowers.? Not too unlike the Uniform Lifetime tables used by the IRS for life expectancies in several situations, FHA has a life expectancy table for Home Equity Conversion Mortgages (HECMs pronounced “heck’em”) that runs to just age 100.? So the older someone is, the more access to equity they have because it’s theoretically one less year of interest that could accrue and that risk is on the lender and insurer (FHA) .? *Proprietary/Jumbo reverse mortgages don’t have that FHA insurance, so they cover the risk in their loan portfolios by charging a higher rate and oftentimes requiring minimum balances up front.

Interest rate. Interest rates affect the Principal Limit intuitively because the higher the interest rate, the faster the balance could grow. That puts the lender and insurer at risk because if the borrower “beat the bank” so to speak and the accrued loan balance got higher than the appraised value, the bank and insurer have to eat the overage while the borrower walks away smiling or laying even more peacefully in their grave.? The higher the interest rate, the faster the balance grows, so they will lower the starting amount.? An example I just saw was a $5000 difference available just from last Thursday to this Monday because the 10-yr treasury jumped back up last week.? They had $282,000 available last Thursday and by waiting they now only have $277,000 available.? Conversely, as interest rates decrease, the amount they have access to increases, so if the 10 yr kept dropped another 10-20 bps, they may have upwards of $290,000 they could take back out of the house they already had paid off without ever having to pay it back with anything other than future home equity later.? That’s because actuaries project the potential balance growth and at a lower expected rate, they can afford to lend more up front.

Appraised Value. Lastly, the appraised value affects the amount of equity available because the terms of the loan get locked-in based off of the current appraised value, regardless of what happens afterward to values.? Even if values were to crater later, the borrower got access to the present value of a much higher number and the risk was transferred to the lender.? If values increase, that’s just more equity they have if they ever wanted to sell or distribute at death.? If values keep going up or rates decrease, they can simply refinance later getting access to more or a lower rate.? We estimate the value upfront, but adjust the numbers once the actual appraisal comes in.

So what?? The homeowners most at risk of limited options from property decreases before getting a reverse mortgage in place are those that already have existing mortgage balances.? ? The reason is because the reverse mortgage has to be “first lien position” or in other words all other liens have to be paid off first to do the reverse.? So if property values decrease, there are a lot of borrowers who wouldn’t even be able to do a reverse mortgage without coming in with extra cash to pay down their current mortgage.? Many people I talk to couldn’t have even done a reverse mortgage up until the last year because they didn’t have enough equity before property values spiked.??They are also the ones who would feel the most immediate financial relief they’ve ever felt by being able to get into a reverse now so it's important to identify them and let them know it's ok to look at a reverse mortgage.

An example. Let’s say hypothetically someone bought a home 5 years ago for $500,000 and put $100,000 down so they had a $400,000 loan balance and principal/interest (P/I) payments of $1800/month or $20,000/year.? They realize by not having that monthly burden of $20,000 in mortgage payments they know they’ll either have more wiggle room to deal with inflation without changing their lifestyle, withdraw less from their portfolio to pay the mortgage, or even free up that money to begin to transfer wealth while alive through gifting rather than waiting to do it when they’ll never see the benefits or help their family most when the really need it. They also realize they also wouldn’t have a payment to miss eliminating the risk of losing the home to foreclosure if they ever missed or couldn’t make that payment.? They can do what they want with it, even save it, but know they will sleep better with it.?

Today the home appraised at $800,000, but they still owe $350,000.? They started with $100,000 in equity, but in just 5 years, from paying down $50,000 out of pocket payments and appreciation now they have $450,000 in equity from doing nothing else.? Not a bad return using what is commonly considered “safe leverage”, $350,000 return on $100,000 if they sold today, but they don’t want to sell it, just use the appreciation to get rid of the mortgage payments they thought they’d be stuck with for life when they bought it.??

Based on rates and being in their early 70s, they now have $400,000 available to borrow (principal limit) using a reverse mortgage.? But remember they have to pay the existing $350,000 balance off first which would save $20,000 annually in principal/interest (P/I) payments until their late 90s, while even leaving an additional $50k available they could take in cash or line of credit.??

If the home value dropped to $650,000, they would only have $325,000 available to borrow which wouldn’t even be enough to extinguish the existing mortgage.? They would be required to come in with an additional $25,000 out of pocket, which most people don’t want to do even though mathematically the break even isn’t very long.? So in that case what most people do is curse the reverse mortgage, and decide to either “sell and rent” opening up all kinds of life/financial issues and future risks, just keep paying the $1800/mo P/I as long as they want to live in the house, or sometimes choosing the path of least resistance which often times compounds the exact issues they are trying to squash opting for a forward Home Equity Line of Credit (HELOC) because of enticing low costs to “get into it”.??

HELOCs and HEILs can be appropriate in many short-term situations or when someone is very uncertain whether they want to stay in the house, but most people don’t understand the nuances or look how it impacts them down the road which can be very ugly in a downturn.? There are unforgivable additional payments creating more risk of losing the house with a missed payment on either loan, they are not “non-recourse” like a reverse mortgage meaning they can get underwater owing more than the value, and it’s like a ticking time bomb until it amortizes or risk of not being able to recast if they can’t get through underwriting.