Are you 62 or older and have you recently considered accessing the equity in your home? Perhaps you would like to make some home improvements, or maybe you have some bills and the extra money could help alleviate the burden. Home equity continues to be the biggest asset Americans own. We at The Aramco Group would like to present an informative look at the 2 main types of home equity options available for seniors 62 and older, a Home Equity Line of Credit (HELOC) and a Reverse Mortgage.
We will first take a look at the Home Equity Line of Credit option. The HELOC is, in essence, a second mortgage on your home in the form of a line of credit. The entire loan amount is made available to you but it gives you the freedom of choosing how much and when it is withdrawn over a specified period of time, typically 10 years known as the “draw” period. During this period interest-only monthly payments are typically made but ONLY on the amount that is withdrawn. When the draw period is over, the loan amortizes over the remaining term in which it is repaid and no more draws are allowed. In determining the actual line of credit a consumer may receive, a lender will look at numerous factors which include: income, debts, credit history, home value and other financial obligations. Once approved, the HELOC works more like a credit card because it has a revolving balance where the home serves as collateral. Because a home is often considered a consumer's most valuable asset, many homeowners use a home equity line of credit for major items, such as education, home improvements, or medical bills. However, it is typically available with a lifetime adjustable rate capped at 18% rather than periodic interest rate caps. Those that want some form of certainty when it comes to paying their monthly interest payments will be dissatisfied by this feature because your interest rate will change every time the Fed moves the Federal Funds Rate which impacts the prime rate. One of the major drawbacks is that you could end up owing more on your first mortgage and HELOC combined than the actual value of your home, which means refinancing or selling your home could come with great difficulty. As mentioned above, a HELOC tends to be in the form of interest-only payment terms which means you will not be reducing the principal balance and at the end of the loan term you will owe the entire balance to the lender in a lump sum.
Now let’s take a look at the Reverse Mortgage or Home Equity Conversion Mortgage (HECM). The main advantage with a HECM is that you will not have any mortgage payments for the remainder of your life in your current home, regardless of the interest rate fluctuations. Also, you do not have to be concerned with the usual income, credit and asset requirements to qualify for a HECM. A Reverse Mortgage has the flexibility to payout however the borrower prefers as long as one borrower continues to occupy the property as a principal residence. It can be in the form of Tenure payments – equal payments for as long as the borrower lives in the primary residence. Term Payments – fixed number of payments for specified period of time. A Line of Credit – unscheduled payments or in installments, at times and in an amount of your choosing until the line of credit is exhausted. Or you may choose any combination of the above mentioned payouts. If you were to choose the Line of credit option for the Reverse Mortgage and compare it to the HELOC, the Reverse Mortgage would be a better option because its adjustable rate in today’s market is usually capped at or below 13% compared to 18% offered by the Home Equity Line of Credit. The Reverse Mortgage line of credit option also has a growth rate. The growth rate on the unused portion in the line of credit is determined by the current interest rate on the loan plus 1.25. For example if the current rate is 3.0%, the growth rate will be 4.25%. If and when the interest rate on the loan increases so does the growth rate on the line of credit, meaning even more funds become available to the borrower over time. At closing you may be required to pay an origination fee, mortgage insurance premium (MIP), appraisal fee, and a service fee set-aside. (For a more detailed understanding of these costs please read our previous blog below “The Costs Associated with a Reverse Mortgage). However, you may finance the costs into the loan amount rather than pay for them out of pocket. The good news is that the HECM Saver product can save you thousands of dollars in closing costs and can eliminate your upfront mortgage insurance (2% of your home value, up to $12,500). So, low closing cost options are available, but you may receive less cash or a lower amount of a line of credit or average equivalent to about 10% of the value of the home. Some HECM saver products are even offered with lower or no origination fees, further reducing your closing costs.
As you can see each option has its advantages and disadvantages just as any other comparison a consumer does. With this blog post we wanted to bring an informative look at both options to hopefully help assist those that are currently in the decision-making process of choosing a home equity line of credit or a reverse mortgage. Please feel free to contact us here at The Aramco Group if you have any questions, our knowledgeable team will be more than happy to assist you in any questions you might have.