I need to straighten something out that is both important and widely misunderstood.
HECM is the acronym used to describe the federal government’s insured mortgage program for homeowners over age 62… it stands for Home Equity Conversion Mortgage. It’s also described as a “reverse mortgage,” which makes it sound like something that should be avoided if possible.
The term “reverse mortgage” has a certain stigma attached to it. Some people think that having a reverse mortgage means that the bank will own your home, which is not true. Others think that reverse mortgages are expensive, which is also not accurate.
But the HECM really shouldn’t be called a “reverse mortgage.” It should be called a “retirement mortgage,” because that’s what it is. A HECM mortgage is simply an FHA insured mortgage designed specifically and exclusively for homeowners over age 62… those in or approaching retirement.
The key difference between a HECM and a traditional mortgage is that with a HECM, you get to decide when you make payments on the loan. You can decide to make monthly payments of principal and interest, in which case it works the same way a traditional mortgage works.
Or you can decide to make interest only payments, in which case your principal balance stays the same. You can also decide to make no payments on the loan, in which case the interest gets added to your balance.
Here’s a simplified example of how the HECM works…
Let’s say you have a home worth $500,000 and you take out a HECM Line of Credit and borrow $100,000, perhaps to remodel your kitchen and bathrooms, or maybe to improve your cash flow after you’ve retired. And let’s say the interest rate is five percent. That means that the interest on the $100,000 HECM is $5,000 a year.
If you pay the $5,000 a year, then your balance would stay at $100,000. If you decided to pay $10,000 a year, then your balance owed would go down by $5,000 a year. And if you decided to pay nothing all year, then your balance would go up by $5,000, meaning that at the end of that year, you’d owe $105,000.
The advantage to the HECM is that you decide how much you want to pay each year… you control the mortgage instead of the mortgage controlling you. You decide if you want to make a monthly payment… or maybe you want to make a payment every quarter… or maybe you only want to make one payment each year.
It’s totally up to you, and with a HECM, you can never be late on your payment because there’s no due date. Whenever you decide to make a payment on your HECM Line of Credit… you’re on time.
Now, with a HECM, you do have to pay your property taxes, insurance, and normal maintenance… but you never have to make a payment on the loan. Pretty simple, right?
How the HECM gets repaid…
If you decide not to make any payments on your HECM Line of Credit, then your loan will be repaid when you and your spouse die or sell the home. Let’s use the same example that we used above.
The home is worth $500,000. You borrow $100,000. The interest rate is five percent and after 15 years of you making no payments on the loan, the interest has added up and you owe roughly $200,000… and you decide to sell the home.
In that case, the first $200,000 from the sale of your home would go to pay off your HECM Line of Credit. The rest of the sales proceeds would go to you or your heirs. Simple as that.
But remember… when you took out the HECM Line of Credit your home was worth $500,000, but 15 years later it’s highly likely that your home will be worth quite a bit more than it was 15 years ago.
If your $500,000 home were to appreciate by four percent a year, then 15 years later, your home would be worth roughly $900,000, so after selling it, you’d pay off the $200,000 balance on your HECM Line of Credit, and the remaining $700,000 would go to you or your heirs, in the event of your death.
Again, it’s pretty simple and straightforward, right?
Other HECM Line of Credit advantages…
There are other advantages to the HECM Line of Credit, especially when compared to a HELOC, which stands for Home Equity Line of Credit.
A HELOC is a credit line on which you are required to make interest only payments for the first 10 years. After that, if you don’t refinance the loan, it becomes “fully amortizing,” meaning you start making monthly payments of principal and interest. That means that if you can’t refinance the loan your monthly payments will jump up by quite a bit.
HELOCs are terrible loans for older homeowners because of that. Let’s say you take out a HELOC at age 70, but at age 80 you are unable to qualify to refinance the loan, which means that you’ll have to start making the higher monthly payments. No one wants news like that at 80 years old.
The HECM Line of Credit never requires you to make a payment. You can make payments whenever you want to, but you never have to. That alone makes the HECM Line of Credit a safer choice for older homeowners.
The other key advantage to the HECM Line of Credit as compared to the HELOC is that HELOCs can be cancelled by the bank at any time. That’s right… you can think you have a HELOC credit line for emergencies, but you can never be certain because the bank can decide to close your credit line whenever it wants to.
The HECM Line of Credit can never be cancelled, so you know it will be there if and when you need it.
But there’s another important advantage to the HECM Line of Credit… it’s guaranteed to increase every year by whatever the interest rates is… plus half a point. So, if your interest rate were 5.5%, then your HECM credit line would increase by six percent a year… even if your home went down in value, your HECM credit line would increase every year.
Nothing else will do that… nothing.
Let’s say that you opened a $200,000 HECM Line of Credit at age 65… and you never touched it. You just let it sit there in case of an emergency.
Well, 20 years later, when you turn 85, and assuming six percent appreciation, your HECM line of credit will have increased to roughly $650,000… no matter what your home is worth at that time.
In this example, that means that when you turned 85, you’d have a credit line worth $650,000 that you can use tax-free and for any purpose you’d like. Maybe you need the money to pay for in-home care… or maybe you decide to take a cruise around the world… it doesn’t matter, it’s totally up to you. And you’ll never have to make a payment on the money you use. The loan will simply be repaid when you die or sell your home.
And nothing else will do that either.
Better because it’s safer…
The HECM Line of Credit is simply safer for older homeowners. That’s why the program was passed into law by Congress… why it’s regulated by HUD… and why it’s insured by the FHA. It’s a program designed for older homeowners so they can access their home equity later in life without having to make payments on the loan while their alive.
I can’t even count how many older homeowners I’ve seen get into financial trouble. Some are forced to sell their homes to get their equity out… and that’s tragic because it wouldn’t happen had they set up a HECM Line of Credit and allowed it to grow over time.
It’s especially tragic because the reason they didn’t set up a HECM credit line was that they just didn’t know how it worked or how they might use it. They heard some rumor about a “reverse mortgage” that wasn’t true… and they turned away.
This is not a HECM sales pitch…
I’m not writing this because I want to sell you a HECM Line of Credit. I’m writing this because I know for a fact that very few older homeowners know what a HECM really is or how it works. And because they don’t, they never find out a HECM credit line might help them make it through their retirement years.
And not knowing means that people overlook answers that could have made their lives so much better throughout their retirement years. That’s just sad and wrong.
If you want me to help you get your arms around how a HECM Line of Credit can impact your situation, I’m happy to help. Or, if you don’t like me… call someone else. Just don’t ignore the subject because of rumors you’ve heard… because they’re simply not true.
Retirement today…
Retirement today is very different than it was for our parents. For one thing, we’re living longer than ever before, so retirement is now measured in decades, not years. For another, the costs of health care, in-home care, and many other things are far higher than ever before. And for a third, pensions are fewer and farther between than they were for past generations.
It’s just harder to retire today than it was for our parents. That’s a fact and it’s one that you ignore at your peril.
If you want more information on the HECM Line of Credit, you can email me at mandelman@mac.com…
If I can help, I will. And no matter what you decide to do, just remember that knowledge is always power… knowing your options is always better than not.
Hoping this has helped…
Mandelman out.
