REVERSE MORTGAGE or HOME EQUITY LINE OF CREDIT – WHICH IS BEST?
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Senior homeowners have a choice – most make the wrong decision, and don’t know it.
By George Downey
Braintree – Seniors in, or nearing, retirement are confronted with a dilemma – most have failed to save enough for a secure retirement. Moreover, since the baby-boom generation (born after 1946) entered retirement years, ten to twelve thousand are retiring every day. Predictably, this trend will continue another fourteen years through 2030. Retirement experts identify this to be an individual and a national emergency.
Understandably, great numbers of seniors and their advisors are exploring ways to extend savings by using home equity wealth in combination with financial wealth to meet current and future needs. Further, the great majority of seniors state strong preferences to remain in their homes and age in place. So, short of selling the home, the options are limited with most opting to borrow through a traditional home equity line of credit (HELOC) or a reverse mortgage. The dominant reverse mortgage program (over 95%) is the HUD/FHA insured Home Equity Conversion Mortgage (HECM).
Industry records reveal HELOCs are selected 9 out of 10 times over HECMs. Why? The answers are not surprising considering what most know (or think they know) and don’t know about reverse mortgages:
- Lack of knowledge. Homeowners, especially seniors, are familiar with and understand traditional (forward) mortgages. HELOCs offer a low or no cost option that provides ready access to funds when needed, are easy to obtain, and require minimum interest only monthly payments. HECMs, on the other hand, are not well understood and generally viewed in a negative or questionable light as being more expensive, complicated, difficult to get, and promoted by self-serving lenders.
- Misconceptions and myths. Misunderstandings of reverse mortgages are prevalent and, unfortunately, serve to discourage examination at the outset. Common misleading notions include: the lender takes ownership of the house; nothing will be left for the kids; someone told me a reverse mortgage was not a good idea, or it should only be used as a last resort. These and other misconceptions have deterred many from learning more.
- Uninformed advisors. Seniors generally have experienced long and comfortable relationships with their bank and other advisors, and typically look to them first for advice and recommendations. Most banks aggressively promote their in-house HELOC program; don’t offer HECMs; and are not well versed on their attributes or suitability for seniors. As well, friends and other advisors are equally uninformed about reverse mortgages and default to recommending a HELOC, which they are more familiar with.
Important decision
Making the right choice between a HELOC and a HECM is considerably more important than most realize. The right decision requires thoughtful considerations of individual needs and circumstances as well as integration with near and longer term objectives. Too frequently, conclusions are reached without adequate information and/or from advice from others who may not be qualified, or who may be motivated by conflicting interests in the outcome.
Both programs have their place and, like most things in life, have pros and cons, costs, and responsibilities. Which one is the best fit should be evaluated on its suitability for each individual.
Differences
The following chart compares some of the main points that distinguish HECMs from HELOCs and should be considered before a decision is made to choose either.
| HECM | HELOC | |||
| MONTHLY PAYMENTS | NONE | No monthly payments are required for the life of the loan | YES | Monthly payments are required usually interest only for an initial drawn down period then increase to amortize the loan balance to the maturity date |
| UPFRONT
CLOSING COSTS |
VARIABLE | Closing costs include a premium for FHA insurance based on the amount of the initial disbursement. Total costs vary depending on individual factors including program and rate options. Individual quotes are need for accurate estimates. Costs are typically paid from loan proceeds, and may include no cost options depending on origination source and individual circumstances. | VARIABLE | Not FHA insured, so no premium required. Upfront costs vary by lender, but generally feature low or no costs depending on individual lender promotions and borrower circumstances. |
| CREDIT LINE GROWTH GUARANTEED | YES | Undrawn credit line balance grows (compounds monthly) at the same rate (interest + FHA insurance premium) charged on balance owed. Credit line growth is guaranteed and could potentially exceed future property value. Effectively, providing a hedge against property value declines and interest rate increases. | NO | Credit line amount does not grow |
| MANDATORY PAYOFF DATE (MATURITY) | NONE | No maturity date – repayment not required as long as any borrower continues to reside in the property, and loan remains in good standing. | YES | Maturity date usually 30 years, or less. First 7 to 10 years only provide access to funds. In the remaining years – no access to funds. Payments are reset and increased to pay the balance off by the maturity date. |
| LIMITATION ON ACCESS TO FUNDS | NONE | Funds can be accessed any time for the life of the loan as long as the loan remains in good standing | YES | Access to funds is limited to the initial drawn down period normally the first 7 to 10 years only. |
| LENDER OPTION TO FREEZE FUNDS | NONE | Lender cannot freeze access to funds for loans in good standing for the life of the loan | YES | Most HELOCS enable lenders to freeze access to funds with notice |
| PERSONAL LIABILITY | NONE | Non-recourse loan – neither borrower(s) nor heirs have any personal liability. Balance owed can never exceed property value at time of repayment | YES | Borrower(s) are personally liable for any deficiency plus legal and collection costs |
| LENDER FAILURE ELIMINATES FUNDING | NO | If the lender fails, or goes out of business – access to funds and servicing of the loan is not interrupted – FHA will assume responsibility for continued performance | YES | If lender fails, or goes out of business, access to further funding will cease – unless or until another lender assumes responsibility |
| REAL ESTATE TAX DEFERRAL PERMITTED MASSACHUSETTS ONLY | YES | Age and income eligible senior homeowners may defer payment of real estate taxes and have a reverse mortgage | NO | Real estate tax deferral liens have a priority over traditional mortgage or HELOC liens and not permitted by lenders. |
To Learn More
Home equity (housing wealth) is the largest single asset in most households. Thanks to the record setting increases in Massachusetts home values in recent years, housing wealth has become an important and valuable resource to improve financial planning and extend retirement security. If, how, and when to use it is a key question. Every situation is different and the options are increasing as new programs emerge to meet the changing times. If you would like to learn more and explore the possibilities you are welcome to call us for more information or to schedule a private meeting.
About the Author. George Downey (NMLS 10239) is the founder of Harbor Mortgage Solutions, Inc., Braintree, MA, a mortgage broker licensed in Massachusetts (MB 2846), Rhode Island (20041821LB), NMLS #2846. Questions and comments are welcome. Mr. Downey can be reached at (781) 843-5553, or email: GDowney@HarborMortgage.com
Reprinted from the October 2019 edition of the South Shore Senior News.
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