by Daniel J. Turner NMLS#1016716; Geneva Financial LLC NMLS#42056 Copyright 2020 All rights reserved. Use by written authorization only.

 

Early in the Flooring Approach it is important for the Planner to hint/urge/suggest/direct the Client(s) to establish a Reverse Mortgage HELOC. (Of course) your idiots in your B/D “Compliance” department won’t like it, but candidly? They don’t know what they’re doing anyways).

This is contrary thinking to the prevailing conventional wisdom as the Reverse HELOC is considered to be “the loan of last resort” when (in fact) it should be used as soon as the (youngest Client(s) turn 62 years of age.

The primary reason (and other reasons that I will establish in this paper) is to reduce the non-discretionary income needs by making the mortgage payment voluntary instead of mandatory. The absence of the payment makes a lower social security income check stretch farther. It also means more of the monthly income may be saved or invested for future needs or possibly legacy ideas.

For retirement planning purposes, the HELOC is the only responsible program as it provides a Client the ability to manage the debt. Over the past 30 years Reverse Mortgage debt growth (aka “Negative Amortization” or, “Neg-am”) has been one of the cornerstone arguments for NOT using a reverse mortgage, and due to professional indifference and intellectual laziness the idea of using the debt to accomplish retirement planning goals or solve problems has largely escaped the financial planning mindset (to the detriment of millions of Retiree’s).

Structuring the Reverse HELOC can go down several possible paths. By using the terminology of “setting this up”, I mean structuring the program before the underwriting process to ensure future ability to solve issues that may appear either seen or unforeseen. Once the Plan is closed and funded, changing the program can only be accomplished by meeting two ratios and refinancing. It is not simple or easy to refinance a reverse; in many cases, it is impossible.
CONSIDERATIONS FOR BUILDING AN EFFICIENT HECM HELOC PROGRAM 

1. PROGRAM SELECTION

The FHA presently offers 2 HECM programs. They are:

1. Fixed Rate-The Borrower may select from several rate options. Unlike all other forms of mortgage lending, the FHA Reverse does not allow “points”. This fact and consideration is never acknowledged by Advisors while comments about the “expenses” of a reverse are legend. The Fixed rate does not provide a HELOC. For that reason alone, the Fixed Rate plans are unsuitable for use in retirement planning as they eliminate any possible way for the Client to manage the debt. They also deny additional credit to the Borrower that would be available under the “Adjustable Rate” plans.

Due to Regulation Z of the Truth in Lending Act (regarding compensation), fixed rate reverse plans may only charge origination and waive lender credit; or waive the origination and receive Lender Credit. Origination for all FHA FHA Reverse programs are 2% of the first 200,000 of appraised value and 1% for all excess value capped at $6,000.00 up to the current FHA lending cap of $765,600. Lender paid compensation is typically a low end of 1.5% to 12% of the total loan amount (called “UPB”) presently. The rates may change at any time, and they do change often. It is unreliable, and causes concern for thinking Loan officers as many LO’s will offset Borrower expenses with the Lender Credit and run the risk of doing free loans (or worse) being legally committed to come up with resources to pay for disclosed expenses and having a market shock that eliminates possible credit.

“Banks” (Depository Institutions) are NOT required to reveal Lender Credit. Trust me-Almost ALL reverse mortgages provide Lender credit. I choose to disclose mine as compensation.

It is also very important for the Planner and Borrower to understand that Lender Credit does NOT come from the Borrower’s check book or home equity. Just like the compensation for most of the products offered by Planners? It is paid by the Lender as direct compensation. There is no residual income provided to anyone from a Reverse. There is no equity sharing allowed. Fees must be disclosed and must fit within a 110% figure if recommended by the LO. If the fees come in higher? The LO must pay for those overages.

2. Adjustable Rate– This plan offers two choices-

a. Monthly Renewal rates, and

b. Annual Renewal rates

Both plans offer the HELOC and equity growth from the day it funds and on for life. As long as the HELOC has a surplus balance? The Line balance is guaranteed to grow new equity.

Even if the mortgage being paid off (A reverse is a “stand-alone” mortgage and will not allow any other liens on title) and the loan limits are met, and no line of credit is available? Simply paying a dollar will create a $1.00 line of credit. A $10,000.00 payment made will reduce the debt by $10,000.00 and add $10,000.00 to the Line of credit (or create a new $10,000.00 line of credit), and is immediately re-available to the Borrower. Think about that for a minute.

***For our topic, we won’t address the monthly rates as Seniors are often reluctant to see interest rates change every month; it’s just too many “moving parts”. The irony is that the Monthly Rate plan offers a substantially higher interest rate cap that could allow for double digit HELOC growth potential.

2. INTEREST RATE SELECTION

The FHA (insured) HECM HELOC is the only loan model available where the interest rate serves two separate functions.

A. The interest rate is the debt accumulation measurement. High interest rate=higher debt accumulation. Lower rate= lower accumulation. As this may appear to be an obvious point, it has much deeper long term financial planning circumstances, and they’re not negatives.

B. The interest Rate is also the Line of Credit growth measurement. In a Reverse HELOC, the actual line of credit is federally guaranteed to add new equity to the available equity value balance on a daily annualized “annual” (or, rarely chosen “monthly”) renewable rate of interest. This should not be considered a “rate of return” as one could anticipate in an investment or Bank Certificate of Deposit or other similar device; it is the velocity at which new equity is added to the existing credit line as available new credit. It is irrevocable, and is always available for the Borrower(s). In fact, the proposal “Comparison” page clearly identifies this as the “Initial Line of Credit Growth” rate for the HELOC.

Building a HECM HELOC for planning should be considered from the  present and future need issues as several strategies may be built and used, or may be altered and redirected for other “surprise” events.

The interest rate in a Reverse HELOC has 3 components:

1. Index-The index rate is currently the Inter-Continental Exchange Rate (ICE) It is currently approximately .67% and changes daily. The index rate is the cost of funds.

2. Margin-Margin is the Lender’s profit. In the reverse HELOC it is the only way one may accelerate the growth of the HELOC credit line. Higher margin? Higher equity growth. This raises a question regarding the program commonly (mistakenly) asked by Planners and Borrowers “What is the going interest rate for reverse mortgages?” The real question should be, Do you think you’ll need MORE or LESS equity in your future retirement?” The answer is typically more, so using the highest margin possible will aid in accelerating the HELOC growth. ***There IS a bit of a “balancing act” to the use of margin that I will discuss in this paper. However, the knee-jerk reaction by Planners and most Loan Officers unfamiliar with both the reverse and financial planning errantly choose the lowest possible margin and rob the Client of tens of thousands of dollars in future equity and income capacity.

3. FHA Mortgage Insurance Premium (MIP)-Currently, MIP is a contractually fixed rate of 0.50% of the debt balance. MIP provides all the unique qualities and promises and safety features contractually found in the Reverse Mortgage Deed of Trust.

Presently, Reverse Mortgage interest rates are between 2.8% to 3.5% and are a “simple interest” (Rule of 78) function. While the annualized debt and Line of Credit balances compound annually, for a skilled Advisor, these are wonderful advantages in the development of long term strategies.

STRATEGIC USES OF A REVERSE HELOC (Using The Flooring Technique)

1. Re-purposing the Mortgage Paymentb

Review the recent monthly statement for the current mortgage.

-Notice how much of every payment is wasted on mortgage interest that is (not likely) a deductible sum anymore.

-Look how slowly the debt is paid down.

-Look how slowly the ratio of principal to interest changes month to month.

-Considering their reasons for using a Flooring approach, look at all the risks they carry by staying in this kind of loan and avoiding the Reverse mortgage.

-a 30 yr loan is actually 360 chances to default.

-when a Spouse passes on, the income they earned dies with them making a mortgage payment difficult or even impossible.

-when the last spouse passes on, the Heirs must take up the mantle and make payments until the home is released from Probate Court and resources may be legally used to make payments. This can take months, and is a necessary evil as once the home goes into default and foreclosure, Attorney fees, interest, late fees and other loan costs will quickly eat up the inheritable equity.

***A reverse mortgage has NONE of these exposures to loss. NONE of them.

Additionally,

2. The payment is often lop-sided toward useless mortgage interest. Eliminating it means the Client may re-purpose the payment (in part or in whole) towards investments that will represent a 100% principal contribution without surrendering any part of it to a Lender. Interest rate vs investment arbitrage is a very easy and competent way to pay off the mortgage.

3. Look at the monthly payment sum. Look at the monthly income. Divide. This ratio is called “debt-to-Income”, and will typically be 34% to over 50% because that is a lending requirement cap. Lenders will require the debt service may not exceed a certain amount, and typical “cash-out” refinancing will take the Borrower right to that limit. If you make the payment requirement irrelevant (or a choice), the Client may now save the accustomed payment in investments or insurances or a better life style or all of these points.

4. “Flooring” is commonly used when Clients have limited financial means. Using a HECM HELOC can provide the Client with the ability to convert equity to tax-free tenure payments, and allow resources to grow for longer periods and not be required for annuitization until much later in life or possibly not at all. This may open the door for Legacy ideas.

5. Transferring the duty of “Emergency funds” over to the HELOC may allow the Planner to repurpose savings to investment accounts. The HELOC growth rate will also provide an ongoing inflationary hedge for future consideration for either income or other emergency (or both) needs.

6. Use the debt and its growth to shelter investments and provide legal access during a Medicaid crisis. Remember-when one pays into a reverse HELOC? The debt falls, and the HELOC is increased, and begins adding new equity daily. The Spend down may be met much faster when large LEGAL mortgage payments are made into a Reverse. Once the Spouse passes or recovers? Simply repatriate the HELOC back into investments and continue. The large payment will be applied to MIP then mortgage interest. This will trigger a 1098 for mortgage interest paid, and may provide a tax deduction that could be used to offset the income or capital gain taxes triggered by the liquidations.

7. Use the HECM HELOC to cover income taxes triggered by ROTH conversions from traditional to ROTH IRA’s-If the program has enough mortgage debt (interest under MIP) in it, withdraw that sum from the HELOC, and immediately pay it back. This will pay off a sum of mortgage interest that may be used to offset the taxes triggered by the ROTH conversion with the added benefit that the HELOC will be immediately restored (dollar-for-dollar). The tax deduction comes with a “ZERO-COST-BASIS”

8. If tax laws eliminate the deductibility of mortgage interest, the Client may also use the Non-recourse equity line to directly pay the taxes of a ROTH conversion. The growth rate may add new equity to any balance remaining and help (repay) the sum used for the tax payment.

9. If circumstances require filing for Social Security or, if the Borrower has already done so and their recourse provision has expired? They may convert some, part, or all of the credit line into income stream called “Tenure” payments. These are guaranteed for life. If they both leave the home (e.g. Nursing home care), the payout is suspended and the equity is thus protected subject to Medicaid rules on the matter. This is a tax-free income stream, and is not subject to being reported on a 1040. Therefore, taking this income stream will not reduce Social security by raising the income to higher subject tax levels.

10. The Clients may use Tenure Income to supplement their income and allow them to “pretend” they filed for social security. Calculate the amount of income they would receive from Social security at 62. Set up an 8 yr withdrawal program with the lender service agent (found on each monthly statement at the top right corner). At the appropriate age, they may file for SSI and receive a substantially higher monthly income stream and simultaneously stop, reduce, or (if Tenure vs. Term payout is used) continue the full income stream from the reverse.

There are also a substantial number of more “esoteric” uses for a Reverse, but you’ll need to learn how to crawl before you can walk. Most of you thought this was a bad deal until 10 minutes ago. 😉