Few things in life will affect the post-employment life of your older-adult clients as much as their home and their cash flow. This article from Fairway Independent Mortgage Corporation is intended for an audience of financial professionals who are committed to improving the quality of life of older-adult Americans.
There are many older-adult homeowners who would like to downsize, upsize, or right-size into their dream home — or simply a new home that better meets their lifestyle in retirement. These homeowners usually have this in common: They’ve realized that while their current home may have served them well during their prime working/family-raising years, that same home is not ideal for them in their golden years. For example, maybe their current home is too big, too outdated, and too difficult to maintain, with costly repairs that have turned it into a money pit. Where your clients live in retirement influences their family life, hobbies, comfort, safety, cash flow, overall happiness, and so much more.
Despite how a change of scene could be good for their well-being, many older-adult homeowners are choosing to stay put in their current residence. Some reasons for their hesitancy to move may include getting priced out of the housing market; not wanting to take on a new mortgage payment in retirement; not wanting to give up all of the proceeds from the sale of their current home and/or to have to drain their retirement savings to pay in all cash; thinking they can’t afford to move because of other financial obligations; thinking past credit blemishes will disqualify them from being approved for a mortgage; and unease with the current economic environment.
Today’s Housing, Borrowing, and Inflationary Environments
As you know, these days, in much of the U.S., the housing market is tilted sharply in favor of sellers. There’s fierce competition among buyers, interest rates have been rising, inventory is tight, and home prices are at record highs.
According to Fannie Mae, U.S. home prices are expected to rise 10.8 percent this year. That’s on the heels of a nearly 19 percent jump in home prices in 2021. The average interest rate on a 30-year fixed-rate mortgage climbed into the 5 percent territory in April 2022 — that rate had been under 4 percent throughout 2020 and 2021. As if all that isn’t enough for today’s homebuyers to contend with, inflation recently hit a 40-year high. Inflation erodes the purchasing power of current and future cash flows, which can be of particular concern for retirees on a fixed income.
Ways Older-Adult Americans Can Fund the Purchase of a New Home
Historically, there have been two ways to purchase a new home: 1) pay in all cash, or 2) take out a mortgage that requires monthly principal and interest payments.
However, now there’s a third way: Pay using a Home Equity Conversion Mortgage (HECM) for Purchase (H4P) loan.
Most people don’t know that the H4P loan option exists. That’s a shame because older adults who are out of the loop are missing out on an opportunity to have their hesitancy-to-move concerns allayed by a loan product that is designed specifically for them and their needs at this phase of their life.
What Is an H4P Loan?
An H4P loan is a way for homebuyers 62 and older to buy a new primary residence using a HECM (commonly called a reverse mortgage). The H4P loan program is designed to help older adults move closer to their family members and friends; downsize, right-size, or upsize into a home that better suits their current needs and wants, or move to a 55+ Active Adult Community. The H4P program is only available through Federal Housing Administration (FHA)-approved lenders like Fairway Independent Mortgage Corporation. Since the H4P program’s inception in 2008, it has been regulated by the U.S. Department of Housing and Urban Development (HUD) and insured by the FHA.
The homebuyer can purchase a new home by putting as little as 35 percent to 65 percent* of the purchase price down from their own funds — the remainder is funded by the H4P loan. The homebuyer can, and typically does, apply proceeds from the sale of their current home toward the down payment requirement.
While an H4P loan is a mortgage, the borrower is not required to make monthly principal and interest mortgage payments. That’s right, the borrower can defer repayment of the loan balance, so long as they live in the home and pay the property-related taxes, insurance, and upkeep expenses.
So, it feels a lot like an all-cash payment, except your client, as the borrower, gets to keep more of their retirement assets (e.g., keep more of the proceeds from the sale of their current home) to use as they wish, which could help them to keep more assets under your management for a longer duration.
Here’s a Hypothetical Example:
Consider Sue, a retired homeowner, age 73, who wants to relocate and can net $300,000 on the sale of her existing paid-off home. She wants to right-size to a home that’s closer to her family — one that is a single-story and close to the amenities she desires. She finds her ideal home, which is listed at $400,000.
Option 1: Paying all cash
Sue could use all of the proceeds from the sale of her current home ($300,000) and draw down on her retirement accounts (use $100,000 out of her available $200,000 in retirement savings) to pay in all cash and own the home outright. While she wouldn’t be saddled with a monthly mortgage payment, she would have all of her previous home’s equity tied up in another very illiquid asset — her new home. Plus, she would have significantly depleted her retirement nest egg, reducing it from $200,000 to $100,000. Her cracked nest egg could hinder her retirement cash flow strategy going forward and increase the chances of her outliving her savings.
Option 2: Taking out a traditional mortgage
Sue could use about one-third of the proceeds from the sale of her current home to make a down payment on her new home using a traditional mortgage. This way, she can keep more of the proceeds from the sale of her current home to use as she wants (compared to all cash), and she wouldn’t have to dip into her retirement accounts to complete the purchase.
The downside of this approach is she will take on required monthly principal and interest mortgage payments during a phase of her life when her income is significantly less than it was through her prime working years. This repayment obligation, month after month, year after year, will result in a good chunk of her retirement cash flow being directed to and stored in her home — an asset that isn’t easily liquated. Her diminished cash flow in her golden years could make it more difficult for her to weather financial shocks, like a need to pay for her own in-home care.
Then there’s also the issue of today’s rising interest rate environment: borrowing money is more expensive than it was just a few years ago. With a traditional mortgage, the higher the interest rate is, the higher the required monthly mortgage payment is going to be.
Option 3: Using an H4P loan
Sue could use about two-thirds of the proceeds from the sale of her current home to apply toward the down payment of her new home using an H4P loan. This way, similar to the traditional mortgage approach, she can keep more of the proceeds from the sale of her current home to use as she wants (compared to all cash), and she wouldn’t have to dip into her retirement savings to complete the purchase.
The upside of this approach, compared to a traditional mortgage, is that she can defer the repayment of the loan balance, so long as she lives in the home and abides by the loan requirements, which include paying the property charges. This repayment flexibility could help her to establish a more efficient retirement cash flow strategy.
With an H4P loan, she also has increased buying power over the traditional mortgage or all-cash approaches. She’d be well-positioned to compete for her aforementioned ideal home (without needing to drain her retirement accounts or take on a higher monthly payment) if a bidding war broke out, a common reality in today’s competitive housing market.
She could also expand her new home search to include more pricey homes (ones that are double the value of her current home) — essentially, she can purchase a $600,000 home for about half the purchase price down, and still never have to make a monthly mortgage payment again. Of course, she must maintain the home and pay the property-related charges.
NOTE: Story is for illustration purposes only. The persons depicted herein are fictional and any resemblance to actual persons is a coincidence.
How Does a Higher Interest Rate Affect the Loan Balance and Repayment?
As previously mentioned, a higher interest rate affects buyers using a traditional mortgage by way of a higher required monthly interest and principal mortgage payment. If the interest rate on a traditional mortgage is fixed, the required mortgage payments will be the same over the life of the loan. However, if the interest rate is variable, the required mortgage payment will increase and decrease over time, as the interest rate is tied to a benchmark interest rate that moves up and down over time. The portion of the required monthly mortgage payment that goes to the principal reduces the amount the borrower owes on the loan, which can bolster equity in the home.
The H4P loan, which can be either a fixed or variable interest rate, doesn’t require monthly mortgage payments, so long as the borrower lives in the home and meets the loan obligations. That said, an H4P loan is borrowed money, and borrowed money that is not yet repaid accrues interest. The borrower can make prepayments toward the loan balance at any time. However, if the borrower opts to make no voluntary prepayments, the interest, along with any fees, will get tacked onto the loan balance. In other words, the loan balance will grow over time (the higher interest rates, the faster the balance will grow), which can chip away at equity in the home. While the borrower’s home equity may decline with an H4P loan, his or her total net worth may not necessarily decline, as he or she will have freed up cash flow to manage, save, and potentially grow.**
How Does the Interest Rate Affect the Down Payment Amount an H4P Borrower Will Need at Closing?
When calculating the amount of H4P loan funds available to the borrower (and, consequently, the amount of down payment funds that will be needed from the borrower), the expected interest rate (the 10-year Constant Maturity Treasury plus the lender margin) plays a role — along with the youngest borrower’s age and the purchase price of the home.
Generally speaking, the lower the expected interest rate is — the less funds (as a percentage of the total sales price) the borrower will need to bring to closing as a down payment. Here’s an example:
Lower expected rate
- Borrower Age: 73
- Interest rate: 4.75 percent
- Estimated H4P funds available (as a percent of the sales price): 48.9%*
- Higher expected rate
- Borrower Age: 73
- Interest rate: 6.50 percent
- Estimated H4P funds available (as a percent of the sales price): 40.2%*
It is important to note that the loan proceed percentages are estimates based on home values up to the current Department of Housing and Urban Development (HUD) limit of $970,800.
What Properties Are Eligible / Ineligible for H4P Loan Financing?
- Single-family residence
- 2- to 4-unit properties
- Some manufactured homes
- Modular homes
- Planned unit developments (PUDs)
- Approved condominiums
- Mobile homes
- Cooperative units
- Commercial properties
- Working farms
- Investment or 2nd homes
- Condo projects less than 2 units
- Condos not on approved list
- Properties on Indian reservations
What Are the Borrower Eligibility Requirements?
- At least one homeowner needs to be at least 62 years old
- Purchased home must be a primary residence
- Must make a required one-time down payment in cash from a qualifying source(s), such as from the sale of a previous home or from a savings account
- Must complete an FHA-approved counseling session
- Must meet minimal credit and income requirements
- Must move into the new home within 60 days of closing
How Does an H4P Loan Hedge Against Falling Home Values?
As history has shown, the housing market can swing from a seller’s market to a buyer’s market, and vice versa. No one knows for sure when the next housing market downturn will come.
Unlike a traditional mortgage, an H4P loan has a built-in feature that protects the homeowner against the risk of the home becoming upside down. The Federal Housing Administration (FHA) insurance on H4P loans assures the borrowers that they will not be responsible for mortgage debt that accrues beyond the home’s value.
In technical terms, an H4P loan is a non-recourse loan, which means neither the borrower nor their estate will owe more than the value of the home when the loan matures and the home is sold.*** So even if the property value drops, or if one or both borrowers live a very long time while deferring repayment, the homeowners can rest easy knowing they will not be leaving their heirs with a bill.
To learn more, visit Fairwayreverse.com/NAIFA.
Copyright©2022 Fairway Independent Mortgage Corporation. NMLS#2289. 4750 S. Biltmore Lane, Madison, WI 53718, 1-866-912-4800. Distribution to general public is prohibited. All rights reserved. Equal Housing Opportunity.
*This information is provided as a guideline. The required down payment on your new home is determined on a number of factors, including your age (or eligible non-borrowing spouse’s age, if applicable); current interest rates; and the lesser of the home’s appraised value or purchase price.
** This advertisement does not constitute tax and/or financial advice from Fairway.
***There are some circumstances that will cause the loan to mature and the balance to become due and payable. Borrower is still responsible for paying property taxes and insurance and maintaining the home. Credit subject to age, property and some limited debt qualifications. Program rates, fees, terms and conditions are not available in all states and subject to change