In two studies published this year, the Journal of Financial Planning highlighted the use of Home Equity Conversion Mortgage (HECM) popularly known as reverse mortgage line of credit to supplement retirement income.
In Jack Guttentag’s reverse mortgage article series published in Inman News, he laid out the borrowing power brought by the line of credit option. Guttentag is a Professor Emeritus of Finance at the Wharton School of the University of Pennsylvania.
Why do Guttentag and the researchers and financial planners from Journal of Financial Planning considered line of credit the most beneficial payment option among reverse mortgage payment plans?
Below is a list of the advantages of electing for reverse mortgage line of credit:
- Perhaps, the most alluring feature of credit line is its ability to grow until it is exhausted. In HECM line of credit, the unused portion of the credit line grows parallel to loan’s current interest plus half of a percent. Say, a senior has a credit line of $120,000 and made a withdrawal worth of $30,000, the remaining $90,000 will be at $94,950 ($90,000 x .05+.005=Total+$90,000) at 5% interest after a year of non-withdrawal. When the senior elects to withdraw money from the unused portion of the credit line after three years, the available credit will be at around $105,681.72 at 5% interest rate per year, up 17.42% from the original $90,000 unused credit.
- Reverse mortgage line of credit gives the seniors the flexibility to take as much money as they want at initial funding and access the remaining funds as seldom as they want with interest payment limited to the amount of money actually borrowed. Meaning, at $120,000 line of credit, the senior-borrower can take more or less than half of the total credit for initial funding, elect to access the remaining fund after 1, 2, 3 or 10 years, and grow the line of credit in the process. Take note, though, that if you elect for bigger amount at initial funding, the interest will be bigger too.
- It can never be frozen or close for as long as the borrower has a remaining balance in the account. This means that a senior can withdraw portion or all of the unused credit whenever it’s needed.
With the spelled out advantages, majority of reverse mortgage borrowers still elect for a lump sum loan available in fixed rate mortgage (FRM). According to Consumer and Financial Protection Bureau (CFPB), 73% of borrowers in 2011 took all or almost all of their available funds upfront at closing.
Guttentag attributed the trend to borrowers’ confusion about the risk of taking adjustable rate mortgage (ARM). Currently, line of credit is only available for ARM. In forward or conventional mortgage, ARM is considered risky due to the periodic changes in interest rate. So, when seniors are asked to choose between FRM and ARM, the perceived ARM risk comes to play. The perceived risk associated with ARM in forward mortgage, however, does not exist in HECM. In HECM, borrower has no monthly mortgage to pay.
HECM line of credit does not come without costs: seniors will still incur interest charges and the annual insurance fee when they receive their reverse mortgage loan. But with the aforementioned advantages, it is a more viable option for emergency needs. Lenders and Counselors should be able to explain the absence of ARM forward mortgage-like risk in HECM line of credit to help seniors make an informed decision.