This article compares two popular home equity solutions: the traditional HELOC (Home Equity Line of Credit) and the HECM (Home Equity Conversion Mortgage). While both options provide avenues for homeowners to access the value locked in their homes, they cater to different needs and present unique features.
Our goal is to unravel these differences, providing clarity on how each option can align with various retirement strategies. Whether you’re considering supplementing your retirement income or seeking a financial cushion, understanding the nuances between a HELOC and a HECM is crucial for making an informed decision that aligns with your long-term financial goals.
Exploring the Benefits of a Reverse Mortgage Line of Credit
In the evolving landscape of equity tapping, the reverse mortgage line of credit in 2024 stands out, especially with HUD’s recent announcement of higher lending limits. Reverse mortgages can be a compelling alternative to the conventional Home Equity Lines of Credit (HELOC), particularly in certain scenarios for seniors on fixed incomes.
A primary benefit of the reverse mortgage line of credit is its flexible repayment options and unique line of credit growth rate. It empowers you. with the choice to make voluntary payments on the loan whenever you wish, coupled with the convenience of reborrowing. This open-ended nature of the loan is a significant departure from fixed rate closed-end loans.
Additionally, a powerful feature of the reverse mortgage line of credit is the growth of the available credit over time. This aspect ensures an expanding pool of funds ready for unforeseen retirement needs such as in-home care or other related expenses.
With a Reverse Mortgage, you can make repayments
A reverse mortgage is a loan; like most loans, it comes with the required interest. Unlike most loans, that interest does not need to be paid until the loan comes due—typically when the borrower moves from the home or passes away.
Qualifying borrowers 62 or older can receive payments from their home equity under payment plans or take the reverse mortgage as a line of credit.
But borrowers have another choice: paying the interest before it’s due. It may not be an intuitive option, but it can make a significant difference in the potential benefit of your home equity compared to a home equity line of credit.
Reverse Mortgage vs. HELOC Examples
Jack takes home an equity line of credit at age 70. He has a $300,000 home and no existing mortgage.
The following approximations are possible for Jack’s HELOC:
- Jack can get up to $240,000 loan amount (up to 80% loan-to-value)
- Jack decides to borrow $100,000 from his available line
- Interest Rate: Prime + 2.00% amortized over 25 years, or roughly 5.50%
- Mandatory monthly repayment would be $458/interest only or $614/fully amortized
- The rate can change monthly
- Closing costs: $0.00
Jack takes a reverse mortgage as a line of credit at age 70. He has a $300,000 home and no existing mortgage.
He can opt to repay the interest over time, making monthly payments toward that interest, or defer the claim due to repay later.
The following approximations are possible for Jack’s reverse mortgage line of credit.
- Closing costs: $0.00
- Jack can get up to $172,000 loan amount (up to 57% loan-to-value)
- Jack decides to borrow $100,000 from his available line
- Interest Rate: 1-year annual libor +2.75% – 5.1% fully indexed
- If Jack “wanted to,” he could make a monthly repayment to the interest only of $425 or choose to make any additional repayment to the principle
- The rate can only change 1 time per year
Reverse mortgages offer a unique growth feature
Despite being able to borrow a more significant amount under the home equity line of credit, he may be better off in the reverse mortgage line of credit scenario for several reasons.
First, Jack uses the credit line growth feature that Home Equity Conversion Mortgages (HECM) offers. Suppose a reverse mortgage credit line is left untouched. In that case, the unused portion will grow over time, allowing the borrower to access more home equity in the long run.
This can be a wiser option, particularly for younger borrowers just meeting the qualifying age of 62. Many financial planners today advise using a reverse mortgage credit line in this way.
Reverse mortgages also have new rules, including a financial assessment to help ensure borrowers meet their loan requirements. Research shows that retirees who use a reverse mortgage line of credit under this credit line option are less likely to run out of money in retirement than those who do not.
The line of credit was kept as a “rainy day fund” or simply as another “bucket” of money to draw from and replenish a proven strategy gaining appeal in 2016.
Under the reverse mortgage, there is no necessary monthly repayment versus the home equity line of credit that requires ongoing compensation. The reverse mortgage also may offer lighter qualifications, especially if the borrower has no existing mortgage and has a solid financial history.
The loan amount offered by a reverse mortgage line of credit may also be more appropriate for older borrowers, who would like to free up some additional cash flow but may not be prepared to borrow (and repay) a large sum as made available by a HELOC option.
HELOC vs Reverse Mortgage Product Comparison
|Home Equity Conversion Mortgage (HECM)
|Proprietary Reverse Mortgage
|Traditional Home Equity Line of Credit (HELOC)
|Borrower Minimum Age
|Line of Credit Term
|May Be Frozen
|Line of Credit Growth Rate
|$0 Monthly Payment Option
|2-6 Months PITI
|Low/No Closing Costs
|Fixed Interest Rate
**All line of credit programs may be frozen if you fail to maintain taxes and insurance or leave your home as your primary residence. If you enter bankruptcy, courts will not allow you to incur new debt while in BK proceedings, and therefore your line of credit during this time could also be frozen.
What is the difference between a reverse mortgage and a HELOC?
Which is better, a Home Equity Line of Credit or a Reverse Mortgage?
The better option will depend solely on an individual’s circumstances. A HELOC is typically less expensive to establish, benefiting those looking for short-term financing. On the flip side, a HELOC comes with several disadvantages as well. With a HELOC, you have mandatory monthly payments, and the available line of credit is not guaranteed. It can be frozen or eliminated at the lender’s sole discretion. The open-ended period (when you can draw funds) usually lasts only ten years. The mandatory monthly payments also increase significantly when you reach the recast period (usually at the end of 120 months). The loan goes from interest only to principal and interest repayments to pay off over the remaining term. Failure to make timely payments can damage your credit and even result in foreclosure. A Reverse Mortgage will be more expensive to establish the loan as there is mortgage insurance due to HUD, so it is not designed to be a short-term financing solution as it is intended to be the last loan you ever need. With a Reverse Mortgage, your available funds, which can be accessed as a line of credit, scheduled monthly advances, initial cash disbursement, or even a combination of all 3, are guaranteed for as long as you live in the property by HUD. Your line of credit cannot be frozen or eliminated due to market fluctuations, and the unused line of credit grows in availability over time. The funds remain available for as long as the loan is in good standing (the borrower lives in the property as a primary residence and maintains taxes and insurance). There are no mandatory monthly payments on a reverse mortgage, so you cannot damage your credit by missing a monthly payment. Voluntary payments are permitted without any prepayment penalty.
What makes a reverse mortgage line of credit a better option?
What are the disadvantages of a reverse mortgage line of credit?
Are the qualifications different for reverse mortgages vs. HELOCs?
The qualifications are different for HELOCs and reverse mortgages in that reverse mortgages use a residual income method of qualification, vs. the HELOC utilizes an ability-to-repay approach. The residual income method looks at all the borrower’s outgoing debts subtracted from their income. The borrower must have a minimum amount left to live each month. The ability to repay considers the borrower’s debts as a ratio of the borrower’s total income to determine the borrower’s ability to repay the obligation. The residual income method HUD employs for the reverse mortgage makes it much easier for most borrowers, especially those on fixed incomes, to qualify.
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