 |
Guiding borrowers to the right decisions Protecting borrowers from mortgage predators |
Where they overlap in meeting the needs of consumers, I
could find only one situation where the HELOC might work
better than a HECM. In all other situations where both could
be used, the HECM worked better for the borrower. In
addition, the HECM can be used for purposes that the HELOC
cannot touch at all. The downside of the HECM is that you
must be 62 to qualify.
HELOC stands for home equity
line of credit, or simply "home equity line." It is a loan
set up as a line of credit for some maximum draw, rather
than for a fixed dollar amount. For example, with a $150,000
HELOC, the borrower receives the lender’s promise to advance
up to
$150,000, in an amount and at a time of the borrower’s
choosing.
HELOCs have a draw period, during
which the borrower can use the line, and a repayment period
during which it must be repaid. Draw periods are usually 5
to 10 years, during which the borrower is only required to
pay interest. Repayment periods are usually 10 to 20 years,
during which the borrower must pay off the entire balance.
HELOCs can be first mortgages or second mortgages, which the
lender typically retains in its portfolio without insurance.
HECM stands for home equity
conversion mortgage, because it is designed to allow elderly
homeowners who have equity in their homes to convert some or
all of it into spendable funds. They can draw the funds at
closing, intermittently as needs arise, or in the form of
monthly payments for as long as they reside in the house or
for any specified shorter period. Repayment of a HECM is not
required until the borrower dies or moves out of the house
permanently. To qualify for a HECM, however, borrowers must
be 62 or older. HECMs are always first mortgages, are
insured against loss by FHA, and are almost always sold by
the lenders originating them.
Credit Line Differences:
Both HELOCs and HECMs provide borrowers with credit lines
using adjustable rate mortgages. Upfront fees are
substantially lower on the HELOC, but the HELOC borrower
must pay interest on line usage immediately and must repay
the entire balance within the repayment period. In contrast,
HECM borrowers who draw on credit lines are not obliged to
make any payments so long as they reside in the house.
There are also important
differences in how credit line amounts change over time.
With a HECM, the portion of the credit line that is not used
grows month by month at the interest rate on the HECM. The
lender has no discretionary control over this process. With
a HELOC, in contrast, the amount of the initial line does
not change unless the borrower can negotiate an increase,
which is uncommon. But lenders reserve the right to freeze
lines that have not yet been fully used, and they do so when
adverse information emerges about the borrower’s credit or
the market in which the borrower is involved. These
differences affect how the different lines can be used for
various purposes.
Meeting Intermittent But Temporary
Expenses: A borrower 62 or
older faced with the need to finance outlays that will occur
intermittently over future months -- financing additions to
a home, for example -- can finance them with either a HELOC
credit line or a HECM credit line. In both cases, they will
be borrowing with an adjustable rate mortgage that exposes
them to the risk that interest rates will rise during the
draw period.
If the borrower intends to repay the
balance shortly after the outlays have been completed, the
HELOC probably will be more cost-effective, because the
initial interest rate and upfront fees are lower. However,
over extended periods borrowers are more exposed to interest
rate increases on HELOCs because rate maximums are higher
and there are no rate adjustment caps as there are on HECMs.
Managing Fluctuations in Income:
Both HELOCs and HECMs can be drawn against when income is
low, and repaid when income is high. With a HELOC, however,
this can be done only during the draw period.
Protecting Against Adverse Future
Contingencies: Because unused
HECM credit lines grow over time, they provide insurance
against a wide range of adverse contingencies, including
loss of pension income resulting from the death of a spouse,
and exhaustion of the financial assets that were supposed to
last a lifetime but didn’t. HELOCs don’t have this capacity.
With a HECM you can buy a house
and not repay the mortgage used to finance the purchase so
long as you live there. You can’t do that with a HELOC.
With a HECM you can supplement
your monthly income by borrowing a set amount each month,
with no required repayment for as long as you reside in the
house. This is called a “tenure” payment if it continues for
as long as the borrower resides in the house, and a “term
payment” if it terminates after a specified period. Neither
is available on a HELOC.