For someone looking for a hedge against property value risk, a senior may not need to look any further than a Federal Housing Administration (FHA)-sponsored Home Equity Conversion Mortgage (HECM) loan. This is according to Jack Guttentag, aka the “Mortgage Professor,” in a new column published by Forbes.
Tied to the motivation for someone to become a homeowner is the promise of building home equity, a pivotal measurement of a person’s wealth. The owner of the home, however, has little control over the market factors which can affect the property value of the home, and home price appreciation has further variance based on something like geography, Guttentag says.
“A homeowner reaching 62 can begin converting home equity into spendable funds by taking out a HECM reverse mortgage,” he says. “In calculating the amounts that a senior can draw using a HECM, the government assumes the borrower’s house will appreciate by 4% a year. This was the average rate for all areas over a period of many decades.”
The actual rate of appreciation could be 4%, but it’s likely to be higher or lower depending on other things. The key to hedging property value risk through the use of a HECM is because of its nonrecourse feature, Guttentag explains.
“The way the program is designed, the borrower is protected against the adverse consequences of a rate below 4%, and allowed to enjoy the benefit of a rate above 4%,” he says. “The HECM program allows the owner to hedge her property value risk.”
Creating a hypothetical scenario with a borrower named “Jane,” who over time sees the amount owed on the house as more than its value, this borrower is not liable for the deficit between debt and home value, he says.
“There are no deficiency judgments in the HECM program,” explains Guttentag. “Losses such as the one described above are taken as a charge against the Government’s reserve account, which is replenished by insurance premiums paid by Jane and all other HECM borrowers.”
However, in a whole other scenario where Jane’s home appreciates at a value of 8% instead of 4%, her equity could outpace the HECM loan’s balance.
“Jane could leave the equity for her estate, or she could convert it into a larger monthly payment by refinancing,” he says. “That means paying off the balance on the first HECM, and drawing a tenure payment on a new HECM.”
In any event, the HECM program can allow eligible homeowners to to benefit from home price appreciation, “without bearing the risks associated with low or no appreciation. Unusually low interest rates increase the benefits,” he says.
Read the column at Forbes.
