The HECM as a LTCI Alternative

The Home Equity Conversion Mortgage as a Long-Term Care

Insurance Alternative for Financing In-Home Care by Stephen R. Pepe, JD

prolonged in-home care event can devastate an older client’s carefully crafted retirement plan. Past Journal articles, from as recent- ly as September 2016, convey the same message, explaining that— While Medicare covers major medical expenses for those who are 65 and over, the expenses in- volved in a chronic or catastrophic health event can surprise even those who plan well…. The es- timated [health care] expenses the average couple will spend in retirement is $245,000. 1 The traditional, reliable strategy to mitigate the risk of “going broke” in retirement due to a long-term care event is purchasing a long-term care insurance (LTCI) policy. Hopefully, clients will purchase LTCI in time to protect themselves financially in the event of declining health later in life. But there are most likely a number of clients who do not. Maybe they object to or cannot afford the premiums. Perhaps they fail to meet LTCI health underwriting standards because they are among the 90 percent of seniors who have a chronic health con- dition or 80 percent of seniors who have two or more chronic conditions. 2 Others may procrastinate by avoid- ing thinking about and discussing their own mortality. Whatever the reason, only 10 percent of elderly Ameri- cans have LTCI. 3 The rest must find alternatives. Long-term care financing alternatives for affluent clients who enter retirement without LTCI may include self-insuring, or purchasing hybrid life insurance policies A

ABSTRACT The majority of older Americans lack long- term care insurance policies that can finance a long-term care event, which means their retirement savings are exposed to premature and devastating erosion. The $6.1 trillion in home equity owned by households aged 62 and older can serve as a viable in-home care funding source if it is accessed properly. This article explains how the Home Equity Con- version Mortgage (HECM), more commonly known as a reverse mortgage, is an effec- tive tool that enables older homeowners to access home equity to finance in-home care, and why advisors should include HECMs in every long-term care discussion they lead.

Vol. 71, No. 4 | pp. 53-66 This issue of the Journal went to press in June 2017. Copyright © 2017, Society of Financial Service Professionals. All rights reserved.

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requires amechanism to release that equity and transform it into spendable funds. One suchmechanism that is both efficient at unlocking home equity and within the finan- cial reach of millions of older homeowners is the Federal Housing Administration (FHA)-insured Home Equity Conversion Mortgage (HECM). 9 Commonly known as a reverse mortgage, a HECM enables older homeowners to convert a portion of their home equity into income-tax- free funds to pay for in-home care, medical equipment, and home accessibility modifications necessary to en- dure an extended period of declining health in their own homes, all while insulating their other assets from signif- icant depletion. 10 By using the strategies explained in this article, a HECM can outperform many LTCI polices in terms of the amount of monies available for one’s care, the versatility of those funds, startup costs, and ongoing out-of-pocket costs when an owner-occupied home is an older client’s long-term care setting of choice. Cost of In-Home Care Genworth’s 2016 Cost of Care Survey shows that the national median hourly rate for both “Homemak- er Services” and “Home Health Aid Services” is $20 per hour. 11 The national median monthly cost for both of these services combined is $7,674. Singling out five states in five regions of the country, Table 1 provides their monthly median care costs. These costs are limited to the hourly rate for caregiv- ers that visit clients’ homes. They do not include assistive technologies or home modifications. Fewer than 4 per- cent of single-family homes contain all three of what the Joint Center for Housing Studies of Harvard University calls “three of the most critical accessibility features” for older homeowners. 12 Those features include single-floor living, extra-wide hallways and doors, and zero-step en- trances. Therefore, the majority of older homeowners trying to age in place will face disability-related home renovation costs in addition to caregiver costs. HECM Primer This general overview of HECM features pre- cedes the discussion about the different strategies that

and annuities that have long-term care riders. The lat- ter come with substantial initial out-of-pocket costs but can provide meaningful long-term care benefits similar to traditional LTCI products. David A. Gresham, in his Journal article from July 2016, covered these asset-based products in great detail. 4 Clients who lack both LTCI and the resources to self-insure or purchase hybrid insurance and annuity products must rely on their families and pro- grams like Medicare, Medicaid, and Veterans Adminis- tration Aid and Attendance Benefits. Seniors’ desires to age in their own homes sur- face in conversations during client appointments as well as in recent written studies. For instance, in its May 2016 published report, the Bipartisan Policy Center acknowledged that a “substantial majority of seniors” wish to age in place in their own homes. 5 Furthermore, 85 percent of retirees surveyed by Mer- rill Lynch preferred to receive long-term care in their own homes as opposed to assisted living facilities, nursing homes, or family members’ homes. 6 As of 2016, the nationwide median nonhousing net worth of homeowners aged 65 and older was $103,180. 7 Therefore, advisors who examine the totality of their clients’ assets when searching for viable in-home, long- term care financing sources—whether as part of an annual plan review or in preparation of an imminent, foreseeable need—cannot ignore home equity. Homeowners aged 62 and older, who combined own $6.1 trillion of this nation’s home equity, can tap into their home equity to finance their in-home care needs. 8 Because home equity is not a liquid asset, a homeowner

TABLE 1 Monthly Median Care Costs, Homemaker and Home Health Aid Services

Region

State

Median Cost

Northeast Southeast Midwest Northwest Southwest

Massachusetts

$9,505 $7,293 $7,674 $9,472 $7,811

Florida Kansas

Washington

Arizona

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el that might not sustain a recurring LTCI premium payment may still pass HECM financial assessment.

advisors can implement. This primer highlights those program rules that one will encounter in the in-home care context, with less emphasis on other program features one encounters in other financial planning scenarios. Some comparisons between HECMs and LTCI are interspersed throughout this section. General Eligibility An eligible HECM borrower must be at least 62 years old and own a primary residence that is a sin- gle-family home, an owner-occupied multifamily home, an FHA-approved condominium, or a planned unit de- velopment. The home must meet a set of FHA standards addressing safety and structural soundness. Unlike LTCI, advanced age, like being in one’s 80s or 90s, does not neg- atively impact one’s ability to obtain a HECM. In fact, it can actually work to a homeowner’s advantage by increas- ing the amount of available HECM funds. HECMs are compatible with life estates and certain inter vivos trusts. 13 Additionally, there are new regulations and safeguards in place for age-qualified borrowers who have spouses who are younger than 62. 14 Credit and Income Due to the fact that a HECM has no recurring monthly repayment requirement, the absence of sub- stantial income or assets will not necessarily bar a homeowner from obtaining a HECM. 15 However, all HECM applicants are put through a financial assess- ment that analyzes the homeowner’s credit history, property charge payment history, and residual in- come to determine the homeowner’s ability (income) and willingness (credit) to meet his or her property expense obligations (including taxes, insurance, and maintenance). 16 Those who do not meet certain U.S. Department of Housing and Urban Development (HUD) income and credit thresholds will encounter “Life Expectancy Set Aside” accounts, earmarking part of their HECM proceeds for future property tax and insurance payments or, in extreme cases, will have their HECM application denied. Although income matters for today’s HECM applicants, an income lev-

Health One distinct advantage that a HECM has over LTCI is that a HECM lender cannot base any credit decisions upon an applicant’s physical health. There- fore, clients who are denied LTCI for health reasons still have a viable in-home-care financing option with a HECM if they are homeowners. If an applicant has a physical disability that makes signing documents difficult, lenders have procedures for signing docu- ments with a “mark” or allowing the client’s attor- ney-in-fact (AIF), guardian, or conservator to sign the documents in his or her place. Homeowners receiving in-home care frequently suffer from mental impairments like dementia and Alzheimer’s disease. For a homeowner lacking the cognitive ability to understand and participate in a HECM transaction, an AIF under a durable power of attorney (DPOA) or a duly appointed conservator or guardian may complete the transaction on his or her behalf. 17 Just like a physical impairment, a cognitive impairment or neurological disorder will not disqual- ify a client from obtaining a HECM. This is another advantage that a HECMhas over LTCI. In cases where an AIF is signing documents, a lender will require a physician’s letter detailing the homeowner’s cognitive abilities both at the time the DPOA was signed and at the time he or she applies for the HECM. Required Consumer Counseling Every homeowner who wishes to obtain a HECM must undergo a reverse mortgage counsel- ing session with a HUD-approved, nonprofit HECM counseling agency. 18 During the 1- to 2-hour session, conducted in person or by telephone, the counselor explains the HECM program in detail, reviews alter- natives to the HECM program, and tries to ascertain whether anyone is exerting undue influence over the borrower. No steering can occur between counsel- ors and lenders. A HECM lender may not process

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in-home care discussion. These three options will be depicted in case studies in subsequent sections and are introduced below. LOC The homeowner has access to a credit line against which he or she can draw. One key feature distinguish- ing a HECMLOC from a traditional home equity line of credit is a guaranteed growth factor. 21 The unused portion of a HECM LOC experiences guaranteed, income-tax-free growth regardless of any future fluc- tuations in the home’s value. 22 An LOC set up today and left untouched will be larger in one year, 5 years, 10 years, and so on. The LOC growth rate is equal to the HECM note rate plus 125 basis points. 23 There- fore, a HECM with a note rate of 5.00 percent today will have a credit line growth rate of 6.25 percent. The case studies in this article demonstrate how clients can leverage the HECM’s LOC growth rate to build up a substantial source of in-home care funds. Term Payment Term payments are monthly disbursements that end after a certain period of time. The homeowner chooses the size of the monthly disbursement or the length of the term. For instance, a borrower with in- home care costs of $10,000 per month requests month- ly term payments of $10,000. Those term payments end when all of the loan proceeds have been disbursed. Lump-Sum Disbursement The homeowner receives some or all of the loan proceeds as a single, lump-sum disbursement on day one. A client requiring home accessibility modifica- tions or expensive durable medical equipment may choose this option right away. Disbursements and Mandatory Obligations Mandatory obligations typically include mort- gage and lien payoffs, financed closing costs, and first-year set-asides. If a homeowner’s mandatory obligations are less than 60 percent of the principal limit at closing, then he or she may withdraw loan

a homeowner’s HECM application until the home- owner has successfully completed HECM counsel- ing. Again, an AIF, a conservator, or a guardian can complete the counseling on behalf of a homeowner who has cognitive impairments. HECM Loan Amount The amount of HECM loan proceeds that a client can borrow is called the principal limit. The principal limit’s size is determined by the youngest homeowner’s age, the maximum claim amount, and the expected interest rate. 19 The maximum claim amount is a term meaning the lesser of the home’s appraised value or the FHA lending limit. In 2017, the FHA lending limit is $636,150. 20 Example 1: Mr. Rogers owns a house worth $300,000. His maximum claim amount is $300,000. Example 2: Mrs. Brown’s house is worth $1,000,000. Her maximum claim amount is $636,150. Age plays a role in principal limit as well. The older the homeowner, the larger the principal limit. An 82-year-old homeowner can borrow more money than a 62-year-old homeowner living in a house of identical value. Other than influencing the principal limit’s size, advanced old age does not affect a home- owner’s HECM eligibility, unlike with LTCI. In oth- er words, a 90-year-old client might be rejected for LTCI but may still qualify for a HECM. Whether the client is 62 or 102, or owns a home worth $100,000 or $1 million, a HECM will not con- vert 100 percent of the client’s home equity into cash. There will always be an equity cushion to protect against crossover risk, or the risk that the client’s outstanding loan balance exceeds the home’s value. In general, the younger the borrower, the larger the equity cushion. HECM Disbursement Options A HECM borrower has six options for receiving HECM loan proceeds. Three of those options—the line of credit (LOC), the term payment, and the lump-sum disbursement—are most relevant to the

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At the time of repayment, the HECM repayment balance comprises all principal disbursed to the home- owner plus accrued interest, FHA insurance premiums, servicing fees (if any), and financed closing costs. These costs are explained in more detail below. A deceased borrower’s estate can pay off the HECM by selling the home or can keep the home in the family by paying off the HECM with funds on hand, a conventional mort- gage, or the death benefit from a life insurance policy. Nonrecourse Guarantee In case a homeowner’s equity cushion does not withstand future interest rate and real estate market fluctuations, HECMs are nonrecourse loans. 26 The homeowner is not personally liable for the repayment of the debt in instances when crossover occurs and the outstanding HECM loan balance exceeds the home’s value. The only asset from which the lend- er can expect repayment is the home. If the loan re- payment balance exceeds the fair market value of the home at the time of repayment, the FHA will pay an insurance claim to the lender to make the lender whole. Unlike virtually any other mortgage product, the HECM lender cannot commence a deficiency judgment against the borrower or the borrower’s es- tate. All of the client’s other assets and investments are protected from the lender’s reach. Costs This cost discussion divides HECM costs into two categories, out-of-pocket costs and financed costs. Out-of-Pocket Costs HECMs have extremely low out-of-pocket costs when compared to LTCI. One out-of-pocket cost is the HECM counseling agency’s fee, which typically ranges from $125 to $200. The second out-of-pocket cost is an appraisal deposit. FHA appraisals typically cost approx- imately $550 for single-family homes or condominiums and more for multifamily homes. A lender may ask a homeowner to pay some or all of the appraisal fee as a deposit at the time of application. The final potential out-

funds during the first year in amounts up to 60 per- cent of the principal limit. The remaining loan funds can be withdrawn during years 2 and beyond. For the strategies discussed in this article to work effectively, a homeowner client’s mandatory obligations should be below this 60 percent threshold. Otherwise, the HECM may not adequately cover the homeowner’s first year of in-home-care expenses. Example of Mandatory Obligations: Mrs. Blue’s home is worth $200,000, and her principal lim- it is $100,000. Her total mandatory obligations are $4,000. She can withdraw up to an addition- al $56,000 during year one and the remaining $40,000 during year 2 and beyond. (This example sets aside the LOC growth factor to simplify the explanation.) If Mrs. Blue’s in-home care costs to- tal $4,000 per month, or $48,000 annually, her HECM can finance all of her first year care expens- es. If Mrs. Blue’s in-home care costs total $8,000 per month, or $96,000 annually, her HECM will cover only 7 months of her care costs ($56,000). Repayment Unlike traditional mortgages and home equity lines of credit (HELOCs), a HECM has no required month- ly repayment obligation. 24 However, homeowners may make voluntary prepayments in whole or in part with- out incurring a prepayment penalty. A HECM becomes due and payable when one of the following occurs: 25 • All of the borrowers and any qualified nonbor- rowing spouses have died. • All of the borrowers have sold or conveyed their interest in the property. • None of the borrowers has occupied the prop- erty as a principal residence for 12 consecutive months due to physical or mental illness. • The property has fallen into disrepair and the borrower refuses to repair it. • The borrower otherwise violates a mortgage cov- enant (e.g., fails to pay real estate taxes, home- owners insurance, flood insurance, homeowners association fees), leading to default.

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$4,000 (less than 60 percent of the principal lim- it). Her IMIP is $1,000 (0.5 percent of $200,000).

of-pocket cost is a voluntary prepayment that is entirely within the homeowner’s discretion. Again, the homeown- er has the option of prepaying a HECM in whole or part without penalty if the HECM is not due and payable. During a long-term care episode, a homeowner most like- ly will not prepay a HECM in the interest of conserving funds for care-related expenditures. Therefore, the most an average single-family homeowner should expect to pay out-of-pocket to initiate a HECM is about $750. Comparing the HECM’s one-time, out-of- pocket cost to LTCI out-of-pocket premium costs demonstrates a dramatic difference between the two options. According to the American Association for Long-Term Care Insurance’s 2015 Price Index, a 60-year-old couple purchasing $164,000 in immedi- ate LTCI coverage would pay average annual premi- ums ranging from $2,170 to $3,930 per year. 27 Financed Costs Financed HECM costs are separated into four categories that are explained below. These costs are added to the loan repayment balance. In today’s competitive HECM market, lenders frequently offer lender credits to offset some or all of these financed closing costs, thereby reducing the total closing costs charged to the homeowner. The FHA’s initial mortgage insurance premium (IMIP) is a financed closing cost that is subtracted from the borrower’s principal limit. The homeowner’s max- imum claim amount, principal limit, and mandatory obligations determine the size of the initial mortgage insurance premium. 28 If a homeowner’s mandatory obligations are less than or equal to 60 percent of the principal limit, then the IMIP is equal to 0.5 percent of the maximum claim amount. For the purpose of this article and the strategies contained therein, the fo- cus will remain on the 0.5 percent IMIP. IMIP Example: Mrs. Blue’s home is worth $200,000, and her total mandatory obligations are Closing Costs Initial Mortgage Insurance Premium

Financed Origination Fee The financed origination fee is another closing cost that a HECM lender may charge the homeowner. Like the IMIP, it is subtracted from the borrower’s principal limit. HUD sets a $2,500 floor and a $6,000 cap. The formula for everything in between is as follows: • 2 percent of the first $200,000 of maximum claim amount. • 1 percent of the remaining maximum claim amount over $200,000. In today’s competitive market, lenders frequently re- duce or eliminate their origination fees. Advisors and their clients should shop different lenders to assess their origination fee structure. Third-Party Closing Costs This category includes third-party fees and costs that would appear in any typical residential real es- tate transaction. They may vary by lender or state and include the appraisal fee, legal fees, title examination, title insurance, credit report, flood determination, real estate tax certificate, and county recording fees. Interest Homeowners have a choice between fixed and ad- justable interest rates. Interest is assessed against any costs and principal disbursed to the homeowner. The interest is not an out-of-pocket cost but rather is added into the homeowner’s outstanding balance that will be repaid when the loan becomes due and payable. This article focuses on adjustable interest rates because only adjust- able-rate HECMs enable the homeowner to select a LOC or monthly disbursement. Homeowners can choose a rate that changes on either an annual basis or a monthly basis. Fixed interest rates have the advantage of never changing during the life of the loan, but the homeowner is limited to a single, lump-sum disbursement of all loan proceeds at closing. Therefore, a fixed rate is usually a subpar selec- tion for in-home care recipients.

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Ongoing Mortgage Insurance In addition to the IMIP, the FHA charges an ongoing mortgage insurance premium of 125 basis points on top of the lender’s interest rate. This on- going premium is assessed against the homeowner’s outstanding balance. Monthly Servicing Fee HECM lenders may charge a monthly servic- ing fee to cover the expenses involved with day-to- day loan servicing. HUD caps this servicing fee at $35 per month for all monthly adjusting-interest-rate HECMs and $30 for all annually adjusting-rate HECMs. Not all lenders charge servicing fees, and those that do can and do vary on what they charge. The “Low-Cost” HECM Advisors who perform their due diligence will find low-cost HECMs with financed closing costs be- low $1,000. The strategies set forth below all utilize low-cost HECMs. Although there is no particular HECM with the official brand or label of “Low-Cost HECM,” advisors should search for all three of the following within the same HECM: 1. Total mandatory obligations below 60 percent (thereby reducing the IMIP). 2. Low or no financed origination fee. 3. A lender credit that offsets some or most of the remaining financed closing costs. Case Studies The following case studies demonstrate three ex- amples of how a HECM can finance in-home care. The presented subjects are four older homeowners who live in Cape Cod, Massachusetts—a popular re- tirement destination.

the homeowner turns 62, chooses the LOC option, and allows it to grow over the years. Out-of-pocket costs are minimal, and the total annual loan costs re- main low until such time that the homeowner begins drawing against the LOC. Client A Client A owns a $600,000 home on Cape Cod. He is 62 years old and was recently rejected for LTCI because of his preexisting chronic medical condition. Client A’s retirement portfolio is valued at $2 million. Strategy Rather than self-insuring or purchasing a life insur- ance product with a long-term care rider, Client A sets up a low-cost HECMat age 62 with the following features: 29 • Principal limit: $294,600 • Out-of-pocket cost: $300 • Financed closing costs: $175 • Interest rate: 5.42 percent annually adjustable • Monthly servicing fee: none • Disbursement option: LOC • Initial line of credit: $294,425 • Credit line growth rate: 6.67 percent Figure 1 shows the credit line growth projections for the next 30 years. Now assume that Client A, at age 82, suffers a seri- ous health event but can remain at home with the help of in-home care at the cost of $120,000 per year. By the age of 82, Client A will have access to $1,088,392 in the LOC and can afford that level of in-home care for more than 12 years, as depicted in Figure 2. 30 Fur- thermore, Client A will not have to withdraw one cent from his other retirement savings to fund his care during that 12-year period, thereby preserving it for his other necessary and discretionary living expenses, gifting, philanthropy, legacy, or any other use. Essen- tially, his home is paying for his in-home care. Client B Client B is one of the 40 percent of Americans turning 62 over the next 20 years who will have

Case Study 1: Set up HECM LOC as Early as Possible

This is the most effective strategy that offers the greatest possible benefit to the homeowner for the lowest possible overall cost. The key is setting up a low-cost HECM as early as possible, ideally when

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FIGURE 1 LOC Growth over 30 Years

$2,500,000

■ Line of Credit

$2,000,000

$1,500,000

$1,000,000

$500,000

$0

Age 67

Age 72

Age 77

Age 82

Age 87

Age 92

With this pricing option, borrower receives a lender credit covering nearly all closing costs. Up-front cost shown is for a nonrefundable independent counseling fee of approximately $175 on average, which the borrower pays directly to the counseling agency. Not available in all states. Certain conditions and fees apply. Information shown for illustrative purposes only. Assumptions are: (1) 62-year-old borrower; (2) Massachusetts home valued at $600,000; (3) LOC will grow at 1.25% above the adjustable-rate mortgage (ARM), which uses the 1-year LIBOR plus a margin of 3.875%, the initial interest rate is 5.420%, the initial APR is 6.941% as of Sept. 19, 2016, which can change annually, 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 10.420%; (4) the growth rate remains at 6.67%; (5) no draws by borrower. Interest rates and funds available may change daily without notice.

FIGURE 2 $120,000 a Year for In-Home Care, beginning at Age 82

$2,500,000

$2,000,000

$1,500,000

$1,000,000

$500,000

$0

3 years

6 years

9 years

12 years

■ Amount disbursed for in-home care

■ Outstanding balance

■ Home value

With this pricing option, borrower receives a lender credit covering nearly all closing costs. Up-front cost shown is for a nonrefundable independent counseling fee of approximately $175 on average, which the borrower pays directly to the counseling agency. Not available in all states. Certain conditions and fees apply. Information shown for illustrative purposes only. Assumptions are: (1) 62-year-old borrower; (2) Massachusetts home valued at $600,000; (3) LOC will grow at 1.25% above the ARM, which uses the 1-year LIBOR plus a margin of 3.875%, the initial interest rate is 5.420%, the initial APR is 6.941% as of Sept. 19, 2016, which can change annually, 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 10.420%; (4) the growth rate remains at 6.67%; (5) borrower draws $120,000 per year for 12 years beginning at age 82. Interest rates and funds available may change daily without notice.

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$25,000 or less in savings. 31 He owns a home in Cape Cod worth $300,000. Although he wants to remain in his home for the rest of his life, Client B has resist- ed past recommendations to purchase LTCI because he cannot afford the annual premiums, nor can he af- ford an asset-based LTC product like a life insurance policy with a long-term care rider. Strategy Client B follows the same strategy as Client A and sets up a HECM LOC at his current age of 62. Figure 3 forecasts his credit line growth with the fol- lowing features: 32 • Principal limit: $157,200 • Out-of-pocket cost: $300 • Financed closing costs: $175 • Interest rate: 5.17 percent annually adjustable

Even though Client B’s lower home value results in a principal limit of $157,200 (a sum that can be depleted by just one year of in-home care costs), the guaranteed credit line growth ensures that his cred- it line will surge to a sizable amount over time. By comparing the size of the HECM LOC over time to Client B’s $25,000 in savings, the advisor should im- mediately recognize the benefits of implementing this long-term care strategy for similarly situated clients. Without LTCI or a HECM LOC, a long-term care event would wipe out his savings in a matter of weeks. If Client B requires in-home care at age 82 to fulfill his wish of remaining in his home for his lifetime, Fig- ure 4 shows the projected performance of his HECM LOC at a $10,000-per-month withdrawal rate. 33 Case Study 2: Immediate Use in the Absence of LTCI This strategy involves setting up a HECM for a homeowner who is already receiving or about to re- ceive in-home care. Typically, a care plan is already in

• Monthly servicing fee: $30 • Disbursement option: LOC • Initial LOC: $157,025 • Credit line growth rate: 6.42 percent

FIGURE 3 LOC Growth over 30 Years

$1,200,000

$1,000,000

■ Line of Credit

$800,000

$600,000

$400,000

$200,000

$0

Age 67

Age 72

Age 77

Age 82

Age 87

Age 92

With this pricing option, borrower receives a lender credit covering nearly all closing costs. Up-front cost shown is for a nonrefundable independent counseling fee of approximately $175 on average, which the borrower pays directly to the counseling agency. Not available in all states. Certain conditions and fees apply. Information shown for illustrative purposes only. Assumptions are: (1) 62-year-old borrower; (2) Massachusetts home valued at $300,000; (3) LOC will grow at 1.25% above the ARM, which uses the 1-year LIBOR plus a margin of 3.625%, the initial interest rate is 5.170%, the initial APR is 7.207% as of Sept. 19, 2016, which can change annually, 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 10.170%; (4) the growth rate remains at 6.42%; (5) no draws by borrower. Interest rates and funds available may change daily without notice.

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to take over making the $10,000 monthly payments if Client C exhausts all of her assets. Clara is still in the accumulation phase of her own retirement plan. Strategy Set up a HECM with monthly term payments of $10,000 to pay for her in-home care with the follow- ing features, as depicted in Figure 5: 34 • Principal limit: $387,000 • Out-of-pocket cost: $300 • Financed closing costs: $175 • Interest rate: 5.42 percent, annually adjustable • Monthly servicing fee: None • Disbursement option: Term payments of $10,000 for 43 months Setting up the HECM and immediately with- drawing monthly term payments guarantees Client C will be able to afford 43 more months of in-home care while preserving her other retirement assets. This plan enables her to reduce the drawdown rate

place, and it has depleted the majority of the client’s liquid assets. The client and the client’s family mem- bers, advisors, and case workers are searching for a fi- nancing source to extend the in-home care’s duration. Client C Client C is 82 years old and lives in a home in Cape Cod worth $600,000. She never purchased an LTCI policy, and now her chronic health conditions and advanced age prevent her from qualifying. Over the last 3 years, Client C has withdrawn $10,000 per month from her $500,000 IRA to finance her in-home care. After those withdrawals, her IRA’s present value is $140,000. Client C is well enough to remain at home if she can continue to pay for the same level of in-home care, but she and her family are concerned about run- ning out of money before she runs out of time. Client C’s daughter, Clara, promised her mother that she would keep her out of a nursing home at all costs. She told Client C’s advisor that she is prepared

FIGURE 4 $120,000 a Year for In-Home Care, beginning at Age 82

$1,000,000

$800,000

$600,000

$400,000

$200,000

$0

1 year

2 years

3 years

4 years

5 years

■ Amount disbursed for in-home care

■ Outstanding balance

■ Home value

■ Total loan cost

With this pricing option, borrower receives a lender credit covering nearly all closing costs. Up-front cost shown is for a nonrefundable independent counseling fee of approximately $175 on average, which the borrower pays directly to the counseling agency. Not available in all states. Certain conditions and fees apply. Information shown for illustrative purposes only. Assumptions are: (1) 62-year-old borrower; (2) Massachusetts home valued at $300,000; (3) LOC will grow at 1.25% above the ARM, which uses the 1-year LIBOR plus a margin of 3.625%, the initial interest rate is 5.170%, the initial APR is 7.207% as of Sept. 19, 2016, which can change annually, 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 10.170%; (4) the growth rate remains at 6.42%; (5) borrower begins drawing $120,000 per year at age 82. Interest rates and funds available may change daily without notice.

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The Home Equity Conversion Mortgage as a Long-Term Care Insurance Alternative for Financing In-Home Care Stephen R. Pepe

the impact that age has on principal limit. With all else being equal, older homeowners can borrow more. But did Client C have the better outcome in the end? Client A set up his HECM LOC at age 62, when he did not yet need it, which enabled it to grow for 20 years. When he reached 82, the same age as Client C, his LOC exceeded $1 million. His LOC was almost three times larger than that of Client C, who waited until she had an immediate need for cash. Client A’s HECM will fund his in-home care for 12 years, ver- sus Client C, who can squeeze out a little less than 4 years of care. This may be why Dr. Wade Pfau wrote that, “The ability to have an unused LOC grow is a valuable consideration for opening a reverse mort- gage sooner rather than later.” 35 Case Study 3: HECM alongside LTCI A HECM and LTCI can work together hand- in-hand to extend a disabled homeowner’s tenure in his or her home. This strategy demonstrates how to

on her IRA from $10,000 per month to her required minimum distributions. If she is well enough to re- main at home in month 44, she can again turn to her IRA as a funding source for her in-home care needs. This strategy also delays or eliminates the need for Client C’s daughter, Clara, to prematurely employ her own retirement plan. She made a common, albeit emo- tionally charged, promise to keep her mother in place, which could have disastrous consequences for her own financial wellbeing. The HECM enables Client C to rely on her own home equity for nearly 4 more years of in-home care costs and enables her daughter to contin- ue down her own retirement savings path unscathed. Moreover, it also opens up an opportunity for the ad- visor to earn a new client in Clara. Client A and Client C live in homes of identical value and chose HECMs with identical closing costs and out-of-pocket costs. However, Client C borrowed $387,000 at the outset, while Client A’s principal limit was $294,600. These varying examples demonstrate

FIGURE 5 HECM with $10,000 Term Payments

$0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 $800,000

1 year

2 years

3 years

4 years

■ Amount disbursed for in-home care

■ Outstanding balance

■ Home value

With this pricing option, borrower receives a lender credit covering nearly all closing costs. Up-front cost shown is for a nonrefundable independent counseling fee of approximately $175 on average, which the borrower pays directly to the counseling agency. Not available in all states. Certain conditions and fees apply. Information shown for illustrative purposes only. Assumptions are: (1) 82-year-old borrower; (2) Massachusetts home valued at $600,000; (3) LOC will grow at 1.25% above the ARM, which uses the 1-year LIBOR plus a margin of 3.875%, the initial interest rate is 5.420%, the initial APR is 6.941% as of Sept. 19, 2016, which can change annually, 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 10.420%; (4) the growth rate remains at 6.67%; (5) borrower draws $120,000 per year until funds depleted. Interest rates and funds available may change daily without notice.

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The Home Equity Conversion Mortgage as a Long-Term Care Insurance Alternative for Financing In-Home Care Stephen R. Pepe

HECM features: • Principal limit: $294,600 • Out-of-pocket cost: $300 • Financed closing costs: $175 • Interest rate: 5.42 percent annually adjustable • Monthly servicing fee: none • Disbursement options: lump sum and line of credit • Initial lump sum: $53,000 • Initial LOC: $241,425 • LOC growth rate: 6.67 percent This strategy extends the period in which Client D relies on resources other than his retirement port- folio to finance his in-home care from 3 years to 8 or more. At the conclusion of this 8-year plan, Client D still has $322,500 in home equity. Client D did not have to drain his retirement portfolio for his in-home care expenses during the entire 8-year period, thereby extending his portfolio’s longevity and giving it an opportunity to grow. This scenario highlights how HECM funds are unrestricted in their use, allowing for HECM funds to pay for in-home care providers as well as home accessibility modifications, durable medical equipment, and transportation. When is a HECM the Wrong Solution? As with any financial product, there are scenarios in which the advisor may not want to recommend a HECM in the long-term care context. The most obvi- ous example is when the safest and “best” environment for the client is somewhere other than his or her home. If one anticipates an imminent, permanent move to an apartment, assisted living facility, skilled nursing facil- ity, group home, or the home of a family member, then a HECM is a poor fit for that client. LTCI policies are portable and will follow the policyholder wherever he or she lives, whereas a HECM will not. For clients who list home equity preservation as a top priority in their estate plans, a HECM may be a poor fit because of its rising balance over time. If home appreciation does not keep pace with the loan’s outstanding balance, a HECM may erode home eq- uity for heirs. Some clients may be troubled by this if

effectively withstand the LTCI elimination period by tapping into home equity as well as the versatility of HECM funds. Client D Client D recently suffered a stroke that has per- manently confined him to a wheelchair. He is 62, owns a two-story home in Cape Cod worth $600,000, and has a $500,000 retirement portfolio. Fortunately, Client D followed his advisor’s recommendation and purchased a LTCI policy 10 years ago that is still in force. That LTCI policy has a 6-month elimination period and thereafter will pay out up to $6,000 per month in eligible costs for 3 years. Health care pro- fessionals have advised him that he can safely remain at home if he makes certain accessibility-related home modifications and hires an in-home care provider. These are his in-home accessibility modifications and care costs: • Minivan with lift: $35,000 • Doorway widening and threshold removal: $5,000 • Wheelchair ramp to front door: $3,000 • Stair lift, interior: $7,000 • Walk-in tub: $3,000 • In-home care provider at 40 hours/week: $6,000/mo. Strategy Establish a low-cost HECM immediately. With- draw a partial lump sum from the HECM rather than the retirement portfolio to pay for the $53,000 in accessibility modifications and vehicle. Withdraw funds from the HECM LOC during the LTCI elim- ination period to finance the first 6 months of in- home care ($36,000 total). Once the LTCI begins disbursing benefits, allow that to finance the in-home care and stop making withdrawals from the HECM credit line. That will enable the HECM LOC to grow over the next 3 years. Once the LTCI policy is exhausted in 3 years, revert back to drawing from the HECM LOC to finance future in-home care expens- es for 5 more years. This is depicted in Figure 6.

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The Home Equity Conversion Mortgage as a Long-Term Care Insurance Alternative for Financing In-Home Care Stephen R. Pepe

care needs. Unless the number of LTCI policyholders increases significantly, advisors should incorporate a discussion about HECMs into every plan review they conduct with a homeowner client aged 62 and older plus younger clients who have aging parents. n This material has not been reviewed, approved or issued by HUD, FHA, or any government agency. Re- verse Mortgage Funding, LLC (RMF) is not affiliated with or acting on behalf of or at the direction of HUD/ FHA or any other government agency. Massachusetts Mortgage Lender License, License No. ML1019941; Not intended for Hawaii and New York consumers. Reverse Mortgage Funding LLC, 1455 Broad St., 2nd Floor, Bloomfield, NJ 07003, 1-888-494-0882. Compa- ny NMLS ID # 1019941. www.nmlsconsumer access.org. Not all products and options are available in all states. Terms subject to change without notice. Certain conditions and fees apply. This is not a loan commitment. All loans subject to approval. Equal Housing Lender. L864-Exp032018

they wish to leave their home or their home equity to future generations. That being said, advisors should remain observant for children, grandchildren, or other relatives who might try to dissuade their older client against a HECM for this reason even though their older client might stand to benefit greatly from it during their lifetime. Sometimes these relatives do not have the older client’s best interest in mind when they object to a HECM. Conclusion Home equity tapped into through a HECM is an in-home-care funding source that advisors should at best seriously consider and at least further investigate. Even when there is no imminent long-term care event looming over an older client, if that client is 62 or older and owns a home, his or her advisor can implement the strategies described in this article to serve as a valuable alternative or supplement to an LTCI policy. Suitable candidates are not limited to those with immediate

FIGURE 6 HECM Combined with LTCI

$600,000

$500,000

$400,000

$300,000

$200,000

$100,000

$0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

■ Total HECM disbursements

■ HECM balance

■ Remaining home equity

■ Total LTCI disbursements

With this pricing option, borrower receives a lender credit covering nearly all closing costs. Up-front cost shown is for a nonrefundable independent counseling fee of approximately $175 on average, which the borrower pays directly to the counseling agency. Not available in all states. Certain conditions and fees apply. Information shown for illustrative purposes only. Assumptions are: (1) 62-year-old borrower; (2) Massachusetts home valued at $600,000; (3) LOC will grow at 1.25% above the ARM, which uses the 1-year LIBOR plus a margin of 3.875%, the initial interest rate is 5.420%, the initial APR is 6.941% as of Sept. 19, 2016, which can change annually, 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 10.420%; (4) the growth rate remains at 6.67%; (5) borrower draws $53,000 initial lump sum plus six term payments of $6,000 each during year one. Borrower resumes term payment of $6,000 in the 44th month. Interest rates and funds available may change daily without notice.

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The Home Equity Conversion Mortgage as a Long-Term Care Insurance Alternative for Financing In-Home Care Stephen R. Pepe

loan obligations, which include the payment of property taxes, home- owner’s insurance, and other costs associated with home maintenance. (16) Mortgagee Letter 2014-21 (2014), endnote 14. (17) HUD Handbook 4235.1 REV-1(4-6), (4-7A); accessed at: https://portal.hud.gov/hudportal/documents/huddoc?id=42351c 4HSGH.pdf. (18) 24 CFR 206.41; accessed at: https://www.gpo.gov/fdsys/ granule/CFR-2012-title24-vol2/CFR-2012-title24-vol2-sec206-41. HUDHandbook 4235.1 REV-1 (1-9),(2); accessed at: https://portal. hud.gov/hudportal/HUD?src=/program_offices/administration/ hudclips/handbooks/hsgh/4235.1. Mortgagee Letters 2004-25, 2004-48, 2006-25; accessed at: https://portal.hud.gov/hudportal/ HUD?src=/program_offices/housing/sfh/hecm/hecmml. (19)HUDHandbook4235.1REV-1(1-4);accessedat:https://portal. hud.gov/hudportal/HUD?src=/program_offices/administration/ hudclips/handbooks/hsgh/4235.1. (20) Mortgagee Letter 2016-19; accessed at: https://portal.hud.gov/ hudportal/documents/huddoc?id=16-19ml.pdf. (21) 24 CFR 206.3; accessed at: https://www.gpo.gov/fdsys/ granule/CFR-2012-title24-vol2/CFR-2012-title24-vol2-sec206-3. (22) This is not tax advice. One should seek the advice of a tax professional. (23) For HECM loans, the unused portion of the LOC grows at the “credit line growth rate,” which is equal to the compounding note rate. This is the same rate at which the principal limit and the loan balance grow, which is the current interest rate plus the annual mortgage in- surance premium rate (which currently is 1.25 percent divided by 12). Therefore, the amount of funds available to the borrower from a LOC grows larger each month for as long as any funds remain. A proprietary productmay have a lower growth rate than that of aHECMor no growth rate feature, which will affect the amount of cash available to a borrower. (24) As with any home-secured loan, a borrower must meet his/her loan obligations, which include the payment of property taxes, home- owners insurance, and other costs associated with home maintenance. (25) 24 CFR 206.27(c), HUD Handbook 4235.1 REV-1(1-13), 209 CMR 32.33(1)(b). (26) 24 CFR 206.27(8), HUD Handbook 4235.1 REV-1(1-3)C. (27) “Long-Term Care Insurance Costs in 2015,” American Asso- ciation for Long-Term Care Insurance (2016); accessed at: http:// www.aaltci.org/long-term-care-insurance/learning-center/long- term-care-insurance-costs-2015.php#price. (28) Mortgagee Letter 2013-27; accessed at: https://portal.hud.gov/ hudportal/documents/huddoc?id=ML13-27.pdf. (29) Calculations performed September 19, 2016, on Tango Re- verse ™ software. (30) Calculated on October 4, 2016, using Tango Reverse ™ loan fore- casting tool. Assumes 4 percent annual property appreciation rate. (31) Bipartisan Policy Center (2016), endnote 2: 38. (32) Calculated on September 19, 2016, using Tango Reverse ™ software. (33) Calculated on October 8, 2016, using Tango Reverse ™ loan fore- casting tool. Assumes 4 percent annual property appreciation rate. (34) Calculated on September 19, 2016, using Tango Reverse ™ software. (35) Wade Pfau, Reverse Mortgages: How to use Reverse Mortgages to Secure Your Retirement (McLean, Virginia: Retirement Researcher Media, 2016): 68.

Stephen R. Pepe, JD, is a HECM loan specialist with Re- verse Mortgage Funding, LLC. He earned his JD from Suffolk University Law School in 1998 and previously practiced law in the areas of residential real estate convey- ancing, land use, summary process, and estate planning. He is a former AARP Foundation-certified reverse mort- gage counselor and a top-producing reverse mortgage originator. Steve is a frequent contributor in print and ra- dio and a CLE panelist on the topic of reverse mortgages. He can be reached at spepe@reversefunding.com. (1) Sandra Timmermann, “Shocks and Loss in Retirement: Pre- venting Despair, Promoting Resilience,” Journal of Financial Service Professionals 70, No. 5 (2016): 35. (2) “Healthy Aging Begins at Home,” Bipartisan Policy Center (May 22, 2016): 21. (3) Susan Hoover, “Long-Term Care Insurance (LTCI): The Good, the Bad, and the Ugly,” Enterprising Investor blog, CFA Insti- tute, September 19, 2016; accessed at: https://blogs.cfainstitute. org/investor/2016/09/19/the-pros-and-cons-of-long-term-care- insurance/?tc=eml. (4) David A. Gresham, “Seeking Stable, Efficient Coverage for Long-Term Care with Asset-Based Products,” Journal of Financial Service Professionals 70, No. 4 (2016): 47. (5) Bipartisan Policy Center (2016), endnote 2: 17. (6) “Home in Retirement: More Freedom, New Choices,” Merrill Lynch (2014). (7) “Projections and Implications for Housing a Growing Popu- lation: Older Households 2015–2035,” Joint Center for Housing Studies of Harvard University (2016): 54. (8) Jason Oliva, “Home Equity Grows to $6.1 Trillion for Reverse Mortgage-Age Seniors,” Reverse Mortgage Daily, Dec. 20, 2016; accessed at: http://reversemortgagedaily.com/2016/12/20/home- equity-grows-to-6-1-trillion-for-reverse-mortgage-age-seniors/. (9) This material has not been reviewed, approved or issued by HUD, FHA or any government agency. Reverse Mortgage Fund- ing, LLC (RMF) is not affiliated with or acting on behalf of or at the direction of HUD/FHA or any other government agency. (10) This is not tax advice. One should seek the advice of a tax professional. (11) “Genworth 2016 Cost of Care Study,” Genworth Financial, Inc. (2016). Genworth defines “Homemaker Services” as services providing help with household tasks that cannot be managed alone. Homemaker services includes “hands-off” care such as cooking, cleaning, and running errands. “Home Health Aid Services” are defined as “hands-on” personal care, but not medical care, that is provided to people who need more extensive care. (12) Joint Center for Housing Studies of Harvard University (2016), endnote 7: 9. (13) 24 CFR 206.45, 24 CFR 206.35, HUD Handbook 4235.1 REV-1 (4-5), 24 CFR 206.45. (14) Mortgagee Letter 2014-21, U.S. Department of Housing and UrbanDevelopment, November 10, 2014; accessed at: https://portal. hud.gov/hudportal/documents/huddoc?id=14-21ml.pdf. (15) As with any home-secured loan, a borrower must meet his or her

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