HECM: The Expanding Line of Credit
A New Breed of Home Equity Line
We typically advise clients to pay down debt, including the mortgage on their primary residence, as they approach and enter retirement. Even so, we encourage them to take out a home equity line of credit for unexpected contingencies, as a ‘just in case’ option.
Life’s unexpected turns can create an urgent need for immediate cash. You might end up needing money to cover the cost of long-term medical care; offer financial assistance to a struggling family member; finance a major home repair. When these things pop up, our clients come to us seeking advice in identifying the best source from which to withdraw funds.
If current markets make it an inopportune time to withdraw cash, or if the distributions will create a taxable event, a home equity line of credit allows our clients to quickly access cash on a tax-free basis.
The Problem with Traditional Home Equity Loans
Many retirees face challenges qualifying for traditional Home Equity Lines of Credit (HELOC). Most traditional lenders require that the borrower have steady employment income, which most retirees do not have. This is in addition to the typical requirements of high credit score, low debt-to-income ratio, and significant home equity.
“Another recent change is that some of the nation’s biggest lenders have stopped offering home equity loans.” (Interest.com, June 24, 2016)
For those who can get approval for a HELOC, there’s no guarantee they will have access to it in the future as lenders can reduce or call in HELOCs for a variety of reasons. In addition, if one access a HELOC, they will be subject to monthly payments based upon the lender’s terms.
So how does a retiree gain access to credit based on their primary residence and avoid the challenges and disadvantages associated with traditional HELOCs?
Answer: through the FHA Insured Home Equity Conversion Mortgage (HECM).
A HECM uses a revolving Line of Credit, with growth, that enables borrowers – over age 62 – to access cash as needed. The HECM gives borrowers optimal flexibility in that they decide when and how to pay back any cash accessed, not the lender.
Consider this example:
- 65 – Age of the youngest borrower
- $625,500 – Appraised value of primary residence (no mortgage)
- $329,000 – Initial Line of Credit
- 6% – Approximate rate of Credit Growth (regardless of house value)
|Year||Age||Credit Line Available||Loan Balance|
Additional advantages to the HECM:
- Easy to qualify – no credit score or earned income requirements
- Government Backed – insured loan
- Monthly payments not required; although interest and insurance accrue
- Non-Recourse Provision – this insures the borrower can never owe more on the loan than what the house is worth when loan is repaid
- Line of Credit can never be frozen – as long as borrowers meet the terms, the lender can never freeze, reduce, or cancel the credit available
So, what’s the catch to the HECM?
After hearing about the advantages a HECM offers, most people wonder about a catch. Until recently, the major disadvantage to the HECM involved all the upfront expenses and fees, which could add up to thousands of dollars. That’s no longer an issue. Eligible individuals can set up a HECM for as little at $125 up-front cost. Interest and HUD insurance on the amount borrowed create the only ongoing expenses. If nothing is borrowed, there are absolutely no ongoing fees.
Don’t confuse this HECM — also known as a Reverse Mortgage — with the gimmicky Reverse Mortgage you see advertised on television by former prime time soap opera stars.
Most people have negative perceptions about these Reverse Mortgages (HECMs) and for good reason. However, the HECM received a makeover in 2014 that made major positive revisions to the lending terms. What people once thought of as a ‘tool of desperation’ has now become a strategy in the retirement planning process for successful individuals and families.
Contact Rob with questions about Home Equity Conversion Mortgage and how it might fit into your financial plan.
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Rob O’Dell, CFP®, serves clients in our Naples, FL office. With more than 20 years of personal financial planning experience, Rob knows that successful financial planning involves a distinct process, not a one-time event.
Rob has been featured in the Wall Street Journal, Financial Planning Magazine, The Daily Herald and Money Magazine. He was a contributing author on the Third Edition of the Florida Domicile Handbook. Learn more about Rob O’Dell.
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