How to model reverse mortgage

Submitted by DwightKMartin on Sat, 10/08/2016 - 12:44

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Reverse Mortgage

My spouse and I are 60 and just retiring. Cash is especially important to us before taking SS at 70. At 62 I could get a reverse mortgage. I have an expensive home with high equity and a good sized mortgage. I would like to stay in my current home for 10 more years, longer than my cash will last. If I borrow I can stay longer. One way to borrow from my equity would be a reverse mortgage. I tried to model that by reducing the monthly payment on the mortgage to zero, but that was not allowed. I am thinking I will need to open an excel report and do some side bar calculations to see how cash would be affected. The type of reverse mortgage I am thinking about would be a lump sum loan with no monthly payment. Interest, of about 4%, would be added to the loan balance each month. I would continue to pay taxes and insurance. So the factors that I need to input would be the increase in debt until sale, and a reduction in capital gain at sale. I expect this type of calculation will become more common as I hear that reverse mortgages are now more consumer friendly. Thanks, Dwight

Comments

BrianVezza

Tue, 10/18/2016 - 11:58

Hi Dwight,

For reverse mortgage models, here is a simple process. You may need to customize more to meet your specifics.

- Set your home equity to $0
- Add in special expenditures for property taxes (can also include insurance, maintenance, etc.) through end of life (assume these are not income tax related)
- Add in special receipts for reverse mortgage income (income in “dollars” and not taxable, through end of life)

Your lump sum approach can also be modeled. I would add it as a special receipt in the year you expect to receive it.

If you plan to stay until end of life, then you may not need to worry about the accumulating interest. However, you can include that as a side calculation as it fits your specific situation.

Best,
Brian

DwightKMartin

Sun, 10/23/2016 - 18:38

Ok, I could see something like that working. Several things come to mind though:
Net worth would be off. My home value is about 2.4 million, so if I set the value to zero I will have to add that value back in somewhere. I understand a reverse mortgage could be 25% of appraised value, or about 600K. So I would have to make a place for the additional 1.8 million equity. I could call it a money market with no interest earnings.
Then there is the sales event to model. It may be 10 or 15 years out, but I expect to sell at some point to make some of that equity liquid. Factoring in sales costs and capital gains could be a side bar.

The simple model would be to sell the big asset and buy a smaller one sooner. That works for me, cash flow and all. The problem with that is that I really like where I live, so I am looking at options to extend my time here.

I love the quick modeling for most scenarios. I don't see this one working easily. Perhaps an upgrade will include reverse mortgages and refinancing options?
Thanks for the ideas.

chertz

Sat, 10/22/2016 - 11:57

Can’t help you with your question about modeling a reverse mortgage in ESPlanner, but just a couple of thoughts:

The amount of a reverse mortgage loan depends on a variety of factors, including your age, interest rate, etc. Just running some numbers through an online calculator, I suspect the amount you could get would be less than $350K, and much less if you still have a significant first mortgage.

You refer to “a reduction in capital gain at sale.” I may be mistaken, but I don’t think that adding debt changes the cost basis of your house, or the selling price, and therefore a reverse mortgage would have no impact on your capital gain.

Finally, I’m a bit confused by your reference to “make some of that additional equity liquid” down the road; a reverse mortgage, like any mortgage, gives you less equity, not more.

I’m thinking of doing this myself at some point in the future, on a home of similar value, so correct me if you think I’m confused or wrong on any of these points.

DwightKMartin

Sun, 10/23/2016 - 18:53

You make some good points,

I spoke with a lender through Lending Tree, all very preliminary as I am not even 62 yet, two years out for that. They gave me the 25% LTV. Obviously that will have to be confirmed. I expect reverse mortgage loans will continue to evolve over the next couple of years.

On the capital gain comment, yes the gain is what it is regardless of debt.

Brian suggested that I set the equity to zero to model the reverse mortgage. If I do that I will have to add the equity back in somewhere.
I need to calculate cash flow, costs, and net worth.

I really like the graphic depiction of net worth in the report. It shows my real estate is high as a percentage of net worth. My cash gets lower over time after retirement and especially before Social Security kicks in at 70. I need to increase cash or sell the house I enjoy living in. If I have no monthly mortgage payment the need for cash is less. The piper is paid by a reduction in equity rather than cash. Not really liquidity, but a good facsimile.

My comment about liquidity in the above post had to do with a sales event where a less expensive house was purchased, thus turning equity into cash, which is liquid. I edited my comment above to make it more clear.

Other cost implications:
Real estate taxes are high, property values are increasing at a much higher rate (for now). Cash flow v. net worth. If cash is needed now, additional net worth is not so helpful. Higher values are great at point of sale.

Sales costs are about 7%, 5% real estate list and sell, 2% state excise tax.
Cost to sell is 168,000. That seems crazy.
So the cost to sell is 168K plus taxes on the gain over 500K exemption for couples. So the cost to sell might be about 200K.

Right now I am modeling three sales over the rest of my life. Equity in the last house goes to the kids or is a buffer for long term care costs.
Lots of pieces to the puzzle.

chertz

Mon, 10/24/2016 - 21:29

Oh, okay, I see what you mean about making the equity liquid.

Note that Brian’s subsequent note echoes my concerns about the maximum amount available.

I think you’re right that reverse mortgages will evolve, and we’ll just have to see what happens. I’m 13 years older, probably wouldn’t do this for a number of years more (certainly not before paying off my mortgage), so in the fewer years of life remaining to me, an extra 600K of cash would be especially useful.

Hopefully the real estate listing fees will decline a bit more, as Zillow and other online resources are making agents less useful.

BrianVezza

Tue, 10/25/2016 - 14:58

Thanks for sharing chertz. Your note caused me to take another look. There are a lot of reverse mortgage options today and it seems like more are coming. Evaluated correctly in ESPlanner, they can help a lot of people, but are certainly not for everyone.

Best,
Brian

BrianVezza

Sun, 10/23/2016 - 09:29

Hi Dwight,

Try setting up a home with the difference between your reverse mortgage amount ($600K) and home value ($2.4M). This would capture the remaining equity fairly well and you could include the taxes, maintenance, insurance, etc. here.

Regarding the future sale, you could then input a change of home 10 or 15 years out. The assumptions already have a 6% cost for selling a home as a default value.

The $600K can be modeled as non-taxable special receipt. If your regular assets rate of return is very low (assuming the money is in savings/money market), that should be okay.

You'll have to tweak it somewhat to cover the growing reverse mortgage debt through side calculations, but this should get most of it covered. This could be included as a future special expenditure.

While you are at it, it may be worth it to try modeling a monthly income stream for the reverse mortgage instead of the lump sum and see if that works better for you.

Best,
Brian

DwightKMartin

Sun, 10/23/2016 - 18:49

Smart, that sounds like a very good strategy for modeling and much simpler than what I was imagining.
Thank you!

BrianVezza

Mon, 10/24/2016 - 13:51

Hi Dwight,

I took another look at your posts and saw the comment about having a "good sized mortgage". That's really going to limit your benefit from a reverse mortgage.

For example, using http://www.reversemortgage.org/About/Reverse-Mortgage-Calculator, I input a $2.4M home value for a 62 year old married couple (both) and a $200K mortgage, the lump sum amount is fairly small at under $40K compared to the $600K mentioned previously. With no mortgage, you could be a bit above the $300K level depending on specifics and fees. Technically, you could have a higher amount, but a large percentage of the lump sum is listed as "unusable funds" so you really have to look carefully at your options.

There are almost always a number of alternative approaches that you can explore. I've commented elsewhere in the forum on several of these.

Best,
Brian

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