As you move into the golden years of your life, you may be worried about how you can continue to afford your monthly bills – or worse, how to continue living in your home. One potential solution that has re-emerged after tweaks to regulations is the Home Equity Conversion Mortgage (HECM).
HECMs, or “reverse mortgages” as they are sometimes known, have gained such esteem in the past few years that a Professor Emeritus of Finance at University of Pennsylvania’s Wharton School is declaring them a “can’t-miss deal.” Read on to discover more about this unique financing option below.
How Do HECMs Work?
Traditionally, potential homeowners can apply for a Home Equity Line of Credit (HELOC). This has many similarities to the HECM, including that it is secured against the future property, it accrues interest on borrowed amounts, and its rates are typically variable, not fixed. However, in an HECM, a borrower over the age of 62 may pull equity from their home without payments or moving out of the house. The funds from this equity are then disbursed as a lump sum, monthly payments – or the most highly regarded method – a line of credit.
In other words, the “reverse” aspect of a reverse mortgage is that you are given money in exchange for equity in your home that you have previously paid to acquire.
HELOCs vs. HECMs
Unlike an HELOC, the unused line of credit grows at the same rate you pay on used credit. That line of credit remains open as long as you live in your home and follow the terms of your loan. Imagine having a credit line growing with interest rates over the next few decades. This is far superior to borrowing a lump sum and keeping it in a savings account.
Many seniors enjoy the reliability of HECM lines, which remain open and available for immediate needs. HELOCs have developed notoriety for suddenly decreasing lines or being closed entirely, more commonly when the borrower has not drawn from the loan consistently. The HECM allows for more flexibility in determining when, if at all, to use the line of credit.
What’s more, the Federal Housing Administration insures HECMs, which it does not for HELOCs. If the HECM’s balance ever exceeds the value of your home, this government insurance covers the difference, meaning you cannot have negative equity.
The Perks of HECMs
Perhaps most appealing to those considering a reverse mortgage is that, unlike a traditional mortgage, monthly payments are not required. You pay when you want to pay and when you are able to do so. People can make pre-payments if they like, but the due date is typically when the last borrower listed on the loan sells the home and/or leaves it. However, HECM borrowers still have to pay property taxes and home insurance, and they need to provide general upkeep to the property.
Three out of five people who have used an HECM in a lump-sum form pay off the existing mortgage of the very home from which they are borrowing equity. But even if you don’t need to pay off a mortgage and you don’t have any immediate financial concerns, you could still find the HECM beneficial.
Known as a “standby reverse mortgage,” an HECM is particularly helpful in a bear market, to protect savings, to delay taking Social Security payouts, to increase income in retirement, or to further provide a cushion for the fluctuations in financial markets. An HECM may also be used to pay taxes on Roth IRA conversions, rather than using money inside the IRA to pay the taxes, leaving you with more money to grow inside the IRA.
Income from an HECM is not taxed, so this line of credit can be used by those concerned about moving into a higher tax bracket, which would also affect higher premiums if you are enrolled in Medicare Parts B or D. Withdrawals from retirement accounts, on the other hand, are taxed.
Are HECMs Reliable?
New safeguards in the past few years have made HECMs more attractive and a more reliable option for seniors, and even the most stubborn of financial advisers have begun exploring them anew as an effective part of a financial plan through retirement.
The Reverse Mortgage Stabilization Act of 2013 caps homeowners at borrowing 60% of their equity for a year, at which time the remaining 40% becomes available. An Ohio State University study suggested that this regulation would cut default rates in half. Another regulation requires you to prove that you can afford home insurance and property taxes, and non-borrowing spouses are afforded certain new protections.
If you’re approaching the qualifying age of 62, or you are older, you would be wise to consider whether the HECM model is right for you. It is not always suitable for short-term plans, since the fees to set up the line of credit can range in the thousands of dollars, and they cut into equity that could be utilized to move into a smaller home or buying into an assisted-care facility. Furthermore, it may reduce estate value or place your heirs in the position of repayment. Not only that, but current regulations state that the maximum home value is $625,500 – even if your home is worth much more than that amount.
Nonetheless, many seniors are turning to reverse mortgages as an innovative financial tool. It can allow you more freedom in paying bills each month, accounting for future income, and lessening some of the uncertainty that comes with retiring – and all while staying in the home you have lived in and loved for years.
Does an HECM sound like a strategy that would help you? Tell us about it in the comments section below.