In business, a line of credit can help protect and strengthen an enterprise in countless ways. Defensively, the owner can use it to help meet short-term capital needs or, proactively, to seize an offer simply too good to pass up. It automatically gives the business owner more options to nimbly and strategically meet almost any business challenge or opportunity.
Homeowners can similarly access a line of credit. They can use one to remodel and renovate their home, cover everyday expenses, pay off high-interest credit cards, pay off medical bills, or expand the safety net they’ll need should the unexpected strike.
If a homeowner, 62 or older, is considering opening a line of credit to tap some of the equity in their home, they have an important decision to make. They can choose to take out a traditional home equity line of credit (HELOC) or they can choose a HECM (Home Equity Conversion Mortgage) line of credit, which is simply a reverse mortgage loan insured by the Federal Government.
After comprehensively comparing the two, the choice should be quite clear as to which may be the better opportunity for your clients.
What is a HECM Line of Credit?
A HECM line of credit is one of the payout options that reverse mortgage borrowers can select. The loan amount is largely based on their age, the appraised value of their home, the amount of home equity (home value minus amount still owed on the home) and the prevailing interest rate.
To be considered for a HECM line of credit, the borrower must meet some basic requirements:
- Be 62 or older (a non-borrowing spouse may be younger)
- Own and live in their home
- Have substantial equity in the home (it’s okay to still have a mortgage)
The HECM line of credit does not have to be repaid until the borrower leaves the home so long as they maintain the home, continue to pay their property taxes and homeowners insurance, and otherwise comply with the loan terms.
What is a HELOC?
A home equity line of credit, or HELOC, is a loan in which the lender agrees to lend a maximum amount within an agreed period, where the collateral is the borrower’s equity in their house.
There is a definite payback schedule, usually a 10-year draw period followed by repayment period.
Other than the age restriction for HECMs and the payback timetable for HELOCs, the two home equity loans may not seem that different, but now let’s take a closer look.
|HECM Line of Credit||HELOC|
|Can the line be frozen||No||Yes|
|Can the line be reduced||No||Yes|
|Can the line grow||Yes||No|
Borrower must continue to honor all loan terms, including maintaining the home and paying property taxes and homeowners insurance.
The HECM line of credit has an unlimited draw period
A HELOC draw period is the time period that a borrower may access funds from their line of credit. Not all lending institutions are the same, but the average term is 10 years. Once the draw period ends, the borrower cannot borrow from the loan again without refinancing it.
With a HECM line of credit, there is no limit on the number of draws that borrowers can make so long as they haven’t exhausted their limit and comply with all loan terms.
A HECM line of credit can’t be frozen
Typically, with a HELOC, the line of credit can be frozen at any time, especially if the homeowner’s property value drops. This means that, beginning at the time of the lender’s notice, the borrower can no longer draw funds from your HELOC.
By contrast, a HECM line of credit cannot be frozen, even if the borrower’s home falls in value. The borrower must continue, however, to comply with all loan terms such as maintaining the home and paying property taxes and homeowners insurance.
The HECM line of credit can’t be reduced
The amount of a HELOC can be reduced even if the borrower has maintained a solid payment record. Circumstances leading to a reduction could include a drop in the home’s appraised value or a tightening of the lender’s credit standards.
With a HECM line of credit, the line can’t be reduced, regardless of what happens to the homeowner’s property value or credit score. However, the borrower is still responsible for complying with the all loan terms, which include maintaining the home and paying property taxes and homeowners insurance.
Only the HECM line of credit can grow
A HELOC doesn’t contain a growth feature. That said, a borrower could ask the lender to increase their limit, which it may approve if their home value, income or credit rating has increased.
This contrasts with a HECM line of credit, which contains a built-in growth feature. Whichever portion of the line goes that unused automatically grows each month at a rate equal to the sum of the interest rate plus the annual mortgage insurance premium being charged on the loan.
Strategic uses of a HECM line of credit
As you can see, a HECM line of credit is far more flexible and versatile than a traditional HELOC, but now let’s look at three ways your clients can put that flexibility to work for their retirement.
Preserve their main retirement portfolio
If your clients are invested in the stock market, they know what a roller coaster it can be. They also likely know that if they sell upon the first dip or market correction, they will probably miss out on some big gains after their investments have recovered. By having a HECM line of credit in place, they won’t have to be in panic-selling mode. They can patiently wait and ride things out. Instead of selling their stocks to pay for everyday expenses when the market is underperforming, they can draw from their HECM line of credit. After the market sufficiently rebounds, they can resume drawing from their main retirement account. This strategy especially works well if someone has recently retired in a market downturn. By turning to their HECM line of credit during periods of market turmoil, they can minimize their sequence of returns risk.
Fund Long-Term Care
Your clients may be healthy now, but unless they’ve discovered the Fountain of Youth, they know they may face medical challenges down the line. Some money for their long-term care could come from Medicare, Medicaid, traditional health insurance, long-term care insurance, life insurance and other plans, but even if available, coverage may still prove inadequate or inconsistent.
However, if your clients were to open a HECM line of credit early, say, in their mid-60s, and not touch it until their mid-80s, their credit line could easily double during that time, which would alleviate a lot of health-driven cost concerns.
Make Home Improvements
If your clients intend to stay right where they are, but wish to make their home safer and more livable as they age in place, a HECM line of credit can let them remodel at their own pace. Instead of trying to jam all their home improvements into one timeframe, as they would with a HELOC, they can space out the improvements, according to their schedule.
At one time, if you had clients, 62 or older, who wanted a line of credit to fix up their house, pay off some bills or maybe help pay for their child’s wedding, their choice would have been largely limited to a HELOC. To qualify, they likely would have to submit proof of employment and other income and have a solid credit history.
By contrast, a HECM is far more flexible. Applicants don’t need to be employed. Rather, they need to simply demonstrate they can meet their loan terms, including their ability to maintain the home and pay their property taxes and homeowners insurance. And, of course, once they are funded and approved, their line can never be frozen or reduced. But it can grow to meet their future needs.
We hope this article has given you some help with things to think about. Of course, every situation is different. This information is intended to be general and educational in nature, and should not be construed as financial advice.
For industry professionals only – not intended for distribution to the general public.