Ever since the first day our company started originating reverse mortgages, we’ve been asked the question; why not just get a HELOC instead of a reverse mortgage? In this article we explore benefits and drawbacks of reverse mortgages and HELOCs to help guide the consumer to make an educated decision about which loan type, if any is right for them; HECM vs HELOC.
HECM or Home Equity Conversion Mortgage is a Government insured reverse mortgage program that allows senior homeowners aged 62 or older to convert the equity in their homes into cash flow, either by a line of credit, monthly draws, lump sum of cash or a combination of the options. With a HECM, there are no credit or income requirements.
HELOC or Home Equity Line Of Credit is a mortgage that allows the borrower to draw on a line up to a limit approved by the bank. There are no age restrictions; however, this loan does require that the borrower meet certain credit and income requirements.
Round 1: Qualifying For the Loan
HECM: Qualifying is simple. All borrowers on title must be 62 or older. The property should be in good repair, although repairs can be made after closing. The home must be the primary residence. Borrowers must undergo an independent HUD counseling session that lasts about 45 minutes. Currently there is no income or credit qualifying.
HELOC: Qualifying for a HELOC requires an analysis of income, assets and home value. The lender will look at current debt to income to determine if the borrower can afford to make payments on the new loan.
Round 1 goes to HECM reverse mortgage for minimal credit and income qualifying requirements.
Round 2: Cost of Reverse Mortgage vs. HELOC
HECM: The costs involved in a reverse mortgage include an origination fee, an upfront Mortgage Insurance Premium (MIP) and other costs such as title, escrow and appraisal. The maximum origination fee on a HECM is $6,000, however borrowers have the option to choose a rate that may lower these fees. The upfront MIP on the new HECM 0.50% of the maximum claim amount (lesser of the sales price, appraised value, or FHA mortgage limit of $625,500) if less than 60% of available proceeds are used or 2.5% of the max claim amount if more than 60% of available proceeds are used. Other fees vary based on property value and location but are in line with what one would expect on a typical “forward” mortgage.
HELOC: The costs involved with a HELOC are minimal. Typical fees run around $500 and are often times waived. Many HELOCs will have an early closure fee which is designed to recoup any upfront costs the bank may have paid on the borrowers behalf to originate the loan.
Round 2 goes to HELOC for lower costs.
Round 3: Amount of Money That Can be Borrowed
HECM: Proceeds for a reverse mortgage are based on age, property values and existing interest rates. The factor currently ranges between 52.4% loan to value (LTV) for a 62 year old to 75% LTV for a 90 year old when utilizing a 5.0% interest rate. Our reverse mortgage calculator will give more specifics.
HELOC: Most current HELOCs will not lend beyond 80% of the value of the home. However, borrowers will need to qualify using income and debt, so many will not qualify for an LTV that high.
Round 3 is a tie.
Round 4: Loan Terms
HECM: A reverse mortgage has no set “due date.” The loan is payable at a maturity event such as the passing of the last surviving spouse, if the home is sold or if the home is no longer the borrowers primary residence.
HELOC: A HELOC is typically due at the end of 10 years, after which the loan needs to be repaid or refinanced.
Round 4 unanimously goes to HECM.
Round 5: Line of Credit Behavior and Unused Lines
HECM: Both the reverse mortgage and HELOC will only accrue interest on the money drawn or borrowed. Only the reverse mortgage’s line of credit will allow the unused portion to grow at the same rate the borrower is paying on the used portion of the line. This will give the borrower greater borrowing power.
HELOC: A HELOC can be drawn on and repaid over the life of the loan. The downside is that with the current housing market, many lenders are closing borrower’s lines of credit so they can no longer access the funds that were once available to them. A HECM line will always remain open as long as the homeowner continues to meet the guidelines.
Round 5 goes to HECM for the credit line growth rate and the fact that the line cannot be closed like a HELOC at the banks discretion.
Round 6: Interest
HECM: Reverse mortgages have the option of a fixed rate or an adjustable rate. Only the adjustable rate will allow for a line of credit. The rate is based on the 1 month LIBOR plus a margin. The loan has a life cap of 10% above the start rate. So, for example, if the starting rate is 2.50%, the max the interest rate can go to is 12.50%. Interest paid on a reverse mortgage is only tax deductible the year it’s been paid, which for most people will not be until the loan is paid off. Consult a tax adviser.
HELOC: HELOCs are typically tied to Prime plus a margin. Many have a life cap like the HECM, however not all HELOCs are created equal. Many offer a lower introductory rate, which will increase shortly after closing. Be sure to read the fine print. Some HELOCs may allow interest rates to climb to 18%. Interest paid on a HELOC may or may not be tax deductible. Your CPA will know that answer.
Round 6 goes to HECM due to more specific terms.
Round 7: Required Loan Payments
HECM: A reverse mortgage requires NO monthly mortgage payments until the loan terminates. This is one of the main reasons seniors will choose a HECM over a HELOC. No payments frees up much needed cash for day to day living expenses.
HELOC: Typical HELOCs will require that at minimum an interest only payment be made. Payments will increase as the loan balance increases.
Round 7 goes to HECM for no monthly payments. Both loans require that taxes and insurance be paid.
Round 8: Annual Fees to Keep Account Open and Active
HECM: A reverse mortgage will not charge a fee to keep the loan open.
HELOC: Many HELOCs charge an annual fee to keep the line of credit open.
Round 8 goes to HECM for no additional annual fees
Who won the bout in your eyes? Each individual’s situation is unique and can’t be addressed by blanket statements. In general, the main benefit of a HECM reverse mortgage over a HELOC is that reverse mortgages do not require monthly mortgage payments, while a HELOC does. A reverse mortgage need only be paid back at a maturity event such as the death of the last surviving spouse, if the property is no longer the borrowers primary residence, the borrower fails to pay taxes and insurance and/or fails to maintain the property. With a HELOC, the bank has the right to close the line anytime they choose.
The main advantage of a HELOC is the lower upfront costs. Although, the reverse mortgage has evolved to include the HECM Saver, with reduces upfront Mortgage Insurance Premiums (MIP), lowering the overall cost.
When trying to decide between the two loan types, the first question you should ask yourself is if you have the financial capacity to make monthly payments on a HELOC. If the answer is no, then odds are, you may not even qualify for the loan in the first place. Another important question is how long you plan on staying in your home. A short-term solution may be a HELOC. A HECM may be better for homeowners who plan on staying in their home for longer periods of time.
Ultimately, the decision rests in your hands to determine which loan best meets your needs.
Updated July 16, 2014 to reflect the changes to the new reverse mortgage.