The major theme of the two previous articles in this series is that the Home Equity Conversion Mortgage (HECM) has great potential value to senior homeowners planning their retirement. The value is realizable, however, only with the adjustable-rate HECM that provides multiple options for receiving payments.
Many borrowers are electing the fixed-rate HECM, which requires that they draw the full amount of their borrowing power in cash, leaving nothing for the future. In this and the next article, I will leave the realm of generalities and discuss the pros and cons of specific HECM uses.
Pay off a forward mortgage
Part of the received financial wisdom of my generation was that your mortgage should be paid off by the time you retired. That way, no part of reduced retirement income had to be used to pay the mortgage. But too many are retiring today while still burdened with a mortgage, and some are paying it off with a reverse mortgage.
That uses a reverse mortgage to make the best of a bad situation. It replaces debt that must be repaid in monthly installments with debt that doesn’t have to be repaid until the borrower dies or moves out of the house permanently.
The downside is that the cost of the HECM, which includes mortgage insurance and other upfront fees, will usually exceed the cost of the forward mortgage. Further, the senior who must use all or most of the proceeds from a HECM to repay a forward mortgage loses the ability to draw spendable cash from the HECM in later years.
Purchase a house
Some seniors want to become homeowners for the first time — a “better late than never” decision. Others are homeowners now but want to sell their current home and purchase a different one, perhaps smaller or located closer to family.
These are lifestyle decisions that may be well-considered and sound, or they may be hasty and ill-conceived. I have seen both types, but the only general rule I know for avoiding bad decisions is not to act in haste, and consult those who play a role in the plan. It is a particularly bad idea to move in order to be closer to family without first discussing it with them. They could be planning a move of their own!
Given the senior’s decision to buy a house, using a HECM for that purpose beats the alternative of buying with a forward mortgage and paying it off later with a HECM. The advantage is that it requires only one set of settlement costs instead of two. But the downside is the same as that associated with using a HECM to pay off a forward mortgage: In both cases, the HECM is not available to ease the financial burdens of retirement.
Supplement income pending house sale
Seniors planning to sell their house in a few years who need additional funds in the meantime can use a HECM or a home equity line of credit (HELOC). While HELOC borrowers must pay interest on the amounts they draw, over a short period they can increase their draw by enough to cover the interest so that the net cash withdrawal is comparable to the draw on a HECM credit line or term annuity.
The advantage of the HELOC is that the upfront costs are lower — in some cases, zero — and the interest rate in most cases will be lower than the HECM rate plus the HECM mortgage insurance premium. This means that, assuming the borrower withdraws the same amount of cash on both, after any given period the HELOC debt will be lower than the HECM debt. That is the case for using a HELOC to meet short-term needs.
But the HELOC has significant disadvantages that in many cases will shift the balance of advantage to the HECM.
1. The HELOC borrower must qualify based mainly on income and credit, as with any forward mortgage. Many seniors won’t qualify for a HELOC.
2. If the senior changes her mind about selling the house and decides she wants to remain, she is in trouble if she took a HELOC because the HELOC must be paid off. The HECM doesn’t.
3. The borrower using a HELOC as a source of additional cash is dependent upon being able to draw against the unused portion of the credit line. But the lender can cancel the unused line at any time, and will if a question arises about the borrower’s credit, income or property value. This is not a risk with a HECM