More Possible Uses of HECMs
(Fourth of a Series on How, When and Why to Take a Reverse
September 18, 2012, Revised March 29, 2017
One of the valuable features of the HECM reverse mortgage is the multiple options for cashing out equity in the house. Borrowers can take cash, a credit line that grows in size if it is not used, a tenure annuity that pays a monthly stipend for as long as the senior lives in the house, and term annuities which pay a monthly stipend for a period selected by the senior. These options allow HECMs to be used for a variety of purposes, some of which were discussed in Some Uses of HECMs. Some more are considered here.
Invest to Generate Income
exceptions, using a HECM to finance investments is a bad
idea. The recurring cost of funds is the HECM interest rate plus the
FHA mortgage insurance premium. In March 2017, this was
over 5%. To make money, the senior has to earn a return on
investment above the cost, which very few can do in today’s
market except by purchasing financial assets that carry
substantial default risk.
could be the senior who has a thriving business with great
promise that needs additional funding. If I had such a
business and if it came down to using a HECM to keep it
afloat or letting it die, I would probably use the HECM. But
few seniors have thriving businesses.
exception would be the senior who has very high-cost debt,
on credit cards for example. Paying off a credit card
balance on which the senior is paying 20% is an investment
yielding 20%, or well above the HECM cost.
If a senior is
determined to use the HECM to finance the purchase of
financial assets, they should use the fixed-rate version.
Using the adjustable rate version, the senior would be
assuming interest rate risk on top of default risk, because
the ARM rate adjusts monthly or annualy, and could balloon in a very
Use a Credit Line to Meet Unanticipated or Special Occasion Cash Needs
Many seniors have retirement income
that covers their basic recurring expenses, but not much
more. When an appliance unexpectedly breaks that costs money
to fix, or a special occasion arises that costs money to
celebrate, they can’t cope. A HECM credit line is an
excellent way to meet such contingencies.
A HECM credit
line can be drawn on at any time to meet unanticipated
expenses, or for special occasions such as a wedding or a
trip abroad. Credit lines are available only on adjustable
rate HECMs; on fixed-rate HECMs seniors can draw cash at the
outset and that's it.
selecting the credit line option should have sufficient
discipline to avoid drawing on the line impulsively, which
could use it up in a short period. Those who don’t trust
themselves should select a monthly payment option.
For those who
take a credit line, forbearance is rewarded by continual
growth in the unused portion of the line at the interest
rate on the mortgage plus the FHA’s 1.25% annual mortgage
insurance premium. At current rates, the line will grow
about 5% a year. Some prudent seniors have adopted the
policy of drawing on the growth in the line each year for
“luxury” items, leaving the original line intact for
market, I advise seniors to take a credit line ASAP, which
is when they reach 62 and become eligible. Their line will
then begin growing at about 5% a year. When interest rates
rise, the growth rate will automatically increase.
If the senior
waits instead, the initial line they can draw will rise over
time because they are getting older and their house value
may be rising. However, growing older increases their line
by only about 1% a year, which means that their house value
has to rise by 4% a year to match the growth in an unused
credit line. But few houses today are appreciating at 4% a
year. For most seniors, HECM borrowing power will increase
more rapidly by taking out a credit line as soon as they can
-- as opposed to waiting to grow older.