Why is a HECM superior to a HELOC?
Older homeowners often look to a traditional Home Equity Line of Credit (HELOC) to pay for unexpected expenses. If the homeowner has good income and credit, a HELOC should be easy to obtain from a local bank or credit union.
For younger homeowners looking for short-term financing, a HELOC might be a good fit. Maybe they need a new roof, a home addition, or an upgrade. Maybe they wish to pay for a child’s education or a trip to Europe. If they have the ability and desire to pay off the loan quickly, a HELOC may be a good choice.
Many advisors mistakenly recommend HELOCs to older homeowners because it is less expensive than the federally insured reverse mortgage known as a Home Equity Conversion Mortgage (HECM). However, traditional financing is generally not a good idea for retirees on a fixed income, and I would consider both cash-out refinances and HELOCs to be risky options.
There is no doubt that the HELOC is less expensive upfront. However, one should not compare the costs without also considering the incremental advantages one receives from a financial product. With a HELOC, you get what you pay for, and the typical retiree would be better served by a HECM which offers a secure and growing line of credit (LOC).
Here are four reasons why a HECM is superior to a HELOC:
1. FLEXIBILITY
The HECM has no required monthly principal and interest mortgage payment. This flexibility is critical as the borrower ages. Ultimately, the required payments of a traditional HELOC harm retirement cash flow and could risk foreclosure.
2. RELIABILITY
The HECM is not frozen, reduced, or cancelled if the loan is in good standing. Will the funds from a HELOC be there when you need them? Maybe not. Traditional credit lines are often frozen or cancelled during market downturns.
3. VIABILITY
The HECM line of credit (in good standing) is available until the youngest borrower’s 150th birthday if they were to live that long. A typical HELOC has a draw period of 10 years when the loan will amortize or balloon which can put the borrower’s cash flow at risk.
4. GROWTH
The HECM has an available line of credit that grows organically at the same compounding rate applied to the loan balance. This growth feature increases borrowing capacity as the borrower ages. By contrast, a HELOC draw period is limited and has no growth element as shown below.
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Dan Hultquist