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October 4, 2004
"My
wife and I are 64 years old and can qualify for a reverse mortgage on our
current house, but we want to relocate first. Can we buy a new house with a
"forward" mortgage, and then take out a reverse mortgage?"
Yes, but you will have to make a sizeable
down payment on the new house.
When you take out a reverse mortgage, you
must repay any existing forward mortgages on the house. You do that by drawing a
lump sum under your reverse mortgage equal to the balance of the forward
mortgage. The balance must be smaller than the amount you can draw under a
reverse mortgage.
For example, suppose you pay $200,000 for
your new house. A married couple both of whom are 64 can draw a lump sum under a
Home Equity Conversion Mortgage (HECM, which is the FHA reverse mortgage),
secured by that house, of about $105,000. It varies a bit from one county to
another. If you took out a forward mortgage of $160,000 to buy the house, you
would not be able to pay it off with the HECM and therefore would be ineligible.
If you took out a forward mortgage of $100,000, you would be able to pay it off
by drawing on the HECM, but there would be only $5,000 left for other purposes.
That doesn't mean you shouldn't do it.
Eliminating the forward mortgage eliminates the monthly payment on that
mortgage, which frees up your income for other purposes. Further, the unused
part of the line ($5,000 in my example) will grow by 4-5% a year, depending on
future interest rates, so you will have more to draw on in the future if you
don't use it up now.
Obviously your game plan won�t work unless
the down payment on your next house is 50% or more. You can draw only $105,000
on a $200,000 house because you are still very young and the reverse mortgage
lender is going to have to wait a long time before he gets his money back. If
you were both 74, you could draw over $120,000, and would only need to put 40%
down. And if you were both 84, you could draw over $140,000 and would only need
to put 30% down.
Since you must put 50% down anyway, you
should consider putting 100% down � paying all cash for your new house. If you
have the cash sitting in low-yield investments, that would be a prudent move.
You would then have access to your entire HECM credit line which could be drawn
on as needed, while the unused portion would grow by 4-5% a year.
If you can�t make the purchase without taking
a forward mortgage, make sure the mortgage meets your needs, which are
atypical. It should not matter much to you whether the interest rate is
adjustable or fixed, or whether the term is 15-years or 30, because you are only
going to have it a short time. What does matter is the upfront mortgage costs,
which you want to minimize.
Upfront costs consist of points, which are a
lender charge expressed as a percent of the loan; lender fees expressed in
dollars covering different services, but only the total amount matters; and
mortgage broker fees, which can be expressed in percent, in dollars or both. The
trick to avoiding all these costs is to pay an interest rate high enough that
the lender will pay you points, called a "rebate." The best instrument for this
purpose is a 30-year fixed-rate mortgage (FRM) because they carry the largest
rebates.
For example, a lender offering a 30-year FRM
at 6% and zero points might quote 2.75 points at 5.5%, and rebates of 2.125
points at 6.5% or 3 points at 6.75%. You want a rebate large enough to cover the
other lender fees plus the mortgage broker�s fee. If the rebate is larger than
needed for that purpose, however, it won�t go to waste; the excess can be
applied to third party charges, such as title insurance.
Also, you must make absolutely sure that your
loan does not carry a prepayment penalty. Pay careful attention to the Truth in
Lending disclosure statement that you receive. Near the bottom, it will say that
if you pay off your loan early, you either may, or will not, have
to pay a penalty. If it is marked may, it means you will have to
pay a penalty.
Copyright Jack Guttentag 2004
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