Reverse Mortgage Line of Credit: The TRUTH About Pros and Cons
Written by Bill MacDonaldFebruary 9th, 20235 minute read
The Home Equity Conversion Mortgage program, often known as a reverse mortgage, is abbreviated as HECM.
The reverse mortgage is a government-backed mortgage/loan for homeowners aged 62 and up.
As with any loan program, HECMs carry benefits and risks.
A HECM loan can be used to pay off an existing mortgage, home equity loan, and other debts. Retirement is a time to relax and enjoy life's final years. It can mean spending time with the grandkids, do some gardening, or taking up a long overdue hobby or trip.
But the loss of income (or reduced income) during retirement can be a financial hardship.
Read on to weigh the pros and cons — and learn whether an HECM loan might be right for you.
Pros of a HECM Loan
- No loan payment. There is no required monthly loan payment with a HECM loan!
- Six ways to receive the proceeds. The HECM loan comes with six payment options.You have the choice of receiving a lump sum payment up front, establishing a line of credit to draw on as needed, receiving equal monthly installments, or a combination of these options.
- Existing mortgage/equity loan payoff. The lump-sum payment option can be used to pay off an existing mortgage or home equity loan. If you struggle with a monthly mortgage or home equity payment each month, the reverse mortgage may be able to provide relief.
- Property taxes & homeowner's insurance payment. An HECM loan allows you to pay through a line of credit. This payment plan allows the borrower to withdraw a predetermined amount when requested. This option can be used to pay the real estate taxes and home owner's insurance, and you'll be able to pay your lender back over the course of a year.
- Payoff credit cards and other monthly bills. Chances are, an HECM loan's interest rates are lower than those on your credit cards and other monthly obligations. Swapping out the higher interest rate cards and loans with a reverse mortgage could help you save. And remember, you are not obligated to make a payment each month with a HECM loan.
- Protection against unexpected expenses. When you inevitably face an unexpected expense, such as a new furnace or a leaky roof, obtaining a home equity loan may not be possible. Having a HECM line of credit in place can be the solution to an unforeseen financial emergency.
- Supplemental income. According Northwestern Mutual, "One in five Americans (21%) have NO retirement savings at all. One in three Baby Boomers (33%), the generation closest to retirement age, only have between $0-$25,000 in retirement savings." The HECM loan can provide a monthly income for the life of the borrower(s) or for a pre-specified number of years.
- Life insurance premium. You can use the HECM loan proceeds to pay for a life insurance policy. Consider a monthly tenure or term payment to pay a life insurance premium. Needless to say, the tactic should be discussed with a life insurance agent and a HECM lender, and possibly an attorney/financial advisor.
- The HECM loan is non-recourse loan. The HECM loan is backed by HUD/FHA. As such, the loan program does not require full repayment of the loan balance if the home is sold for less than the loan balance. In fact, even if the loan balance exceeds the appraised value, heirs can purchase the home at 95% of the appraised value. Any additional loan balance is forgiven.
- No income tax. The proceeds from a HECM loan are non-taxable. A reverse mortgage is considered a loan by the IRS, consequently, no income tax is required. And a reverse mortgage will not affect your Social Security or Medicare payments.
- Spousal Protection. HUD/FHA permits spouses of reverse mortgage borrowers who are under 62 years of age at the time of settlement to continue living in the home as an eligible non-borrowing spouse.” There are specific requirements for the spousal protection that must be met to allow the non-borrowing spouse to continue residing in the home.
Cons of a HECM Loan
- It's a loan. A HECM loan is just that — a loan. The money obtained is usually repaid from the sales price of the home. That means your heirs will receive less money, or possibly no money when the last borrower passes away or sells the house. That said, it's not all bad news. If the total loan balance exceeds the sales price, the lender will not pursue the difference from the estate or borrower. Also, family members are permitted to purchase the home at 95% of the appraised value.
- Closing costs. Like any other loan there are closing costs — and they can be relatively expensive, possibly more that a typical mortgage. The FHA permits lenders to charge an "origination" fee. The lender is allowed to charge the greater of $2,500 or 2% of the first $200,000 of the home's value, plus 1% of the amount over $200,000. HECM origination fees are capped at $6,000. Some lenders will waive or reduce the origination fees. Additional fees and insurance will pile on even more costs.
- Property taxes and homeowner's insurance. Property taxes and homeowner's insurance are the borrower's responsibility. If the homeowner fails to keep the taxes and homeowner's insurance current, the HECM lender/servicer can foreclose.
- Medicaid and Supplemental Security Income (SSI). Medicaid and SSI eligibility can be affected by a reverse mortgage. Medicaid has monthly income and asset limitations. Choosing a lump-sum benefit that exceeds the asset limit could potentially jeopardize the Medicaid or the SSI benefit. If you are receiving or are contemplating applying for Medicaid or another income/asset limiting program, you should seek guidance from an attorney that specializes in elder law.
- Appraisal requirement. The home will be appraised by the lender. The cost of the appraisal can cost $450 or more. The appraisal fee is paid by the borrower upfront and non-refundable, unless the loan is rescinded within three days of settlement. If the house fails to meet the FHA appraisal guidelines and if there is insufficient equity for repairs or loan payoffs, the appraisal fee is lost.
- Homeowner counseling. HUD/FHA requires borrowers to receive information from a reverse mortgage counselor before applying for a reverse mortgage. The nonrefundable fee is about $125 and like the appraisal fee, the charge is paid upfront. There are some exceptions for very low-income borrowers and certain situations, however, most applicants will have to pay the counseling fee.