Quite possibly the most amazing feature of the adjustable rate HECM product is the line of credit (LOC) and its ability to grow. It is only available on the adjustable rate products, and it is unique in the world of finance. It is also the primary reason Reverse Mortgages are useful in financial planning.
– Understanding Reverse
The Home Equity Conversion Mortgage (HECM) is offered at FIXED rates, which is fine if you want a one-time distribution of funds. The ARM products, however, offer homeowners the flexibility of monthly payouts and an open line of credit. This means one can borrow from it at any time, pay it down, and borrow from it again without restriction. In fact, many will use the LOC to manage cash flow.
There are so many great advantages to having a HECM LOC that I feel I have to list a few here:
- The LOC is LIQUID. If you need funds they are easily accessible. Just simply request them. For this reason, it is an effective emergency fund.
- The LOC is SECURE. The LOC is not capped, reduced, frozen or eliminated as a result of market conditions or property value declines.
- The LOC is NOT “BORROWED” until drawn. For this reason, the available LOC does not accrue interest and mortgage insurance.
- The LOC GROWS.
There are two things that cause HECM LOCs to grow – time and payments. I won’t cover the math behind it here, but the homeowner’s Principal Limit (borrowing capacity) grows naturally at the same compounding rate of the loan balance. This is what produces the increase. For this reason, increases in interest rates can be advantageous for some homeowners as their LOC grows even faster.
Homeowners can also increase their LOC by making payments to reduce their loan balances. The lesson to be learned is that if a homeowner has cash available, it may be prudent to pay down the Reverse Mortgage balance. This will boost their LOC.
Declining property values don’t impact the LOC growth. Consequently, the LOC may even grow to exceed the home’s value. This can also occur when a homeowner holds a LOC for longer periods, or when interest rates rise dramatically causing the LOC to grow faster.
Important to understand
Be aware that if you intend to keep the LOC for financial planning, make sure not to pay down your loan balance completely. This could close your reverse mortgage and close your LOC.
In addition, only the available LOC grows. Some borrowers use all of their funds and wonder why their LOC does not increase the next month. There is simply nothing left to increase
So when you begin to contemplate how you will use a Reverse Mortgage, consider the product type. If you want the predictability of a fixed rate loan, that is certainly understandable. If however, you want to maximize the financial planning advantages of a liquid, secure, and growing line of credit, choose the ARM product.
Order the newest version of my book today to learn more about how Reverse Mortgages can allow older Americans to have more financial freedom. Understanding Reverse is the most comprehensive guide for answering your most common questions about Home Equity Conversions.