 |
Guiding borrowers to the right decisions Protecting borrowers from mortgage predators |
The major theme of the
two previous articles in this series is that the HECM
reverse mortgage 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.
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 down side
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.
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.
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.
Next week:
More potential uses of HECMs.