Interesting word.

ar•bi•trage är′bĭ-träzh″

• noun
  The simultaneous purchase and sale of equivalent assets or of the same asset in multiple markets in order to exploit a temporary discrepancy in prices.

Arbitrage, as applied in debt management, is used to take advantage of market differences (rates of interest, interest structure, investment returns, timing, etc).

For the topic today, we will discuss the use of “arbitrage” with regard to the FHA HECM HELOC and conventional financing. For relating purposes, I use the terms “forward” and conventional” equally to represent any kind of mortgage debt program as either conventional, non-conforming, FHA, VA, Farm, SBA, RHA, USDA…ANY loan with fixed and required payments of principal and (compounded as in “Rule of 72”) interest.

“Experienced” Borrowers will quickly understand and relate to the typical structure of any mortgage; “Compounding” means it’s ALL upfront interest with a very small portion of the payment applied to the actual reason one would acquire a mortgage-the principal debt. A 4% 30 yr fixed-rate mortgage payment is approximately 22% principal. This means initial payments on a $1,000.00/month, $220.00 will be applied to reduce the debt. The remainder goes to the Lender, and is considered “profit”. While this does improve each month, and at yr 22 the payment is $500/500 P & I? One may only conclude this to be a very one-sided offering. To calculate the true expense of a 30 yr loan? Multiply the total P & I payment required each month times 360 payments. Then subtract out the original sum amount borrowed. In this (above) example, the numbers work approximately to $184,000.00 of interest to borrow $100,000.00. No one ever said that “borrowing” had to be cost-efficient. To the point, it is extremely inefficient.

The great news Is that once you cross age 62? You become eligible for one of the most incredible loan programs ever designed. While you may not view the FHA Reverse HECM HELOC that way? You would be wrong. It’s wonderful, and my point is to illustrate several alternatives that will work, are legal, and will help you by giving you significantly greater control over your debt than you have today.

Talking from a financial planning perspective, one sees the inefficiencies in the conventional debt arena, yet few planners are willing to do anything to help you escape this trap. Many of you will die with your current mortgage on your heads, your families will struggle with this loan until the home is sold or refinanced, The forced contribution of $184,000 in mortgage interest (per $100,000 of principal borrowed) is worth a LOT more over the 30 yr period (time value of money), The average Borrower will refinance the same loan 3 times. Each refi uses up another significant bite of equity for closing costs, and laying hands on your developing equity reserve for emergencies or opportunities could take 20-60 days or more, and at (who knows?) what new rate of interest. Let’s look objectively at using arbitrage to restructure your debt to a MUCH friendlier format-“Simple Interest” under the “Rule of 78” structure.

This interest accrues much slower than under compounded structures even to the point that a higher interest rate in a simple interest rate can equal out to a slightly lower rate under the compounded structure. But, the BIG DEAL with the FHA HECM HELOC is the “NON-RECOURSE” function. Meaning, if you wanted to pay off your mortgage? You were committed to that $1,000/mo payment structure (or, you could lose your home). In a reverse? You don’t have any requirement to make payments. They are voluntary. and my point is that making payments of $1,000/mo into a conservative mutual fund or annuity program is substantially safer and much more productive.

“Arbitrage”: Borrowing at low simple interest, and investing at higher compound interest.

You would use the reverse to refi your mortgage debt from compounded debt to simple. Under the current market conditions, I am funding reverses between 3% to 4.625% regularly. Conventional fixed rates are actually the same and a bit higher. These are simple rates. Take the mortgage payment you were making, and invest this sum in a “dollar-cost-averaging” (DCA) strategy. Because you aren’t forced to commit 50-60% (or higher) into a lenders profit margin? 100% of your payment is now PRINCIPAL. and is now invested on your behalf at current rates of 5%-12% After a very short period (typically 8-15 yrs) the investment account is larger than the Reverse mortgage debt. The Reverse borrower may liquidate the needed sum and pay down or pay off the loan balance. The investor may do this any time they feel the reason to do it.

Due to the way the FHA HECM HELOC is structured? Paying down the Reverse mortgage debt triggers an “IRS-1098” for mortgage interest paid that may be used to cover capital gain taxes on the withdrawal. This could be applied to ordinary income as well, including RMD (forced) liquidations from Qualified plans and non-ROTH withdrawals. The serendipity of killing several birds with one stone does not stop with this.

Additionally, As long as the Borrower does not pay off the mortgage (but leaves like a $1,000.00 tail of principal)? Every dollar paid into this program becomes immediately available as HELOC. This HELOC is uniquely different, as it can not be:

1. Canceled or terminated

2. Suspended or frozen,

3. Or reduced. Regardless of the market value, the economy, interest rates or ANY OTHER FACTOR? these points are true, AND

4. The HELOC equity available will grow at the current mortgage rates in force. In other words, many people have asked about “What’s the rate of inerst on those Reeeverse morgaeez?” and the correct answer is, “Do you think you’ll need more or less equity in your future retirement? I don’t know, but, I’ll wager the answer is MORE. as in, “MUCH MORE”. In that case? you’ll want a higher rate of interest (which is the “REVERSE” of conventional lending).

Regardless, it is always the Borrower’s decision to pay off or pay down debt. From an Assets Under Management (AUM) perspective, the point is to manage your wealth to provide you liquidity, and cash flow for your retirement. FEW people understand the term “Sequence of Returns” risk until they look at their investment value statement after a recent market crash (like we just had). Actually, it isn’t the new low value that catches their eye…it’s the number of shares/units that had to be sold at a loss to create this month’s income! THAT is the loss.

QUESTION: What if you set up a reverse mortgage HELOC and use it to “buffer” (as in “protect”) your portfolio by substituting home equity for portfolio liquidations? It would let your portfolio have time to heal. It would also allow you to continue with the same relative monthly income. And, it would mean you would not be required to use additional wealth to make a mortgage payment that’s 60% interest.

QUESTION:

QUESTION: Why wouldn’t your Planner urge you to refi with the FHA HECM HELOC and reduce the “drag” on your portfolio? Because, if no payment is needed, why would you require the withdrawal of excess funds to make mortgage payments that are redundant and unnecessary? Excessive withdrawals for unnecessary payments does absolutely increases the risk of portfolio failure. It means needing to take higher risks to recover…unless you also have a Reverse HELOC and suspend those withdrawals to use non-recourse home equity instead.

I can tell you that as someone who has a significant background in financial planning? Your mortgage payment was a significant bone of contention for me. With it? You LOVED my ideas, but could only afford about $100/month to participate in them. That sucked. If I could eliminate your mortgage payment? THINK of all the GREAT things I could do for you!!! But, you must make those payments because I can’t let you live with me after they take your home under foreclosure. The MORTGAGE PAYMENT rules the roost in EVERYONE’s home…

Unless you’re over 62 and opt out of that costly and inefficient plan.. 😉