In this post, I am going to focus on comparing a HELOC and the HECM (Line of Credit). However, before I get into the details of the comparison, I do need to make sure that we all understand how each of these loans work.
Since I am an expert on HECM’s, but not on HELOC’s I wanted to go to a trusted source. This is how a HELOC is defined at https://www.investopedia.com/mortgage/heloc/:
Home equity loans and HELOCs use the equity in your home—that is, the difference between your home’s value and your mortgage balance—as collateral. As the loans are secured against the equity value of your home, home equity loans offer extremely competitive interest rates—usually close to those of first mortgages. Compared with unsecured borrowing sources, such as credit cards, you’ll be paying less in financing fees for the same loan amount. However, there’s a downside to using your home as collateral. Home equity lenders place a second lien on your home, giving them rights to your home along with the first mortgage lien if you fail to make payments. The more you borrow against your house or condo, the more you’re putting yourself at risk.
A Home Equity Conversion Mortgage (HECM), is an FHA insured loan specifically designed for homeowner’s age 62 and above, that allows them to convert a portion of the value of their home into money, without having to sell their home, give up title or obligate themselves to a monthly mortgage payment. However, since the home stays in the homeowner’s name, it is still the homeowners’ responsibility to make sure the property charges (property taxes, homeowners insurance, HOA fees, etc…) are paid on time.
The HECM offers flexible ways to withdrawal the funds:
- Lump sum (with some restrictions from FHA during the first 12 months of the loan)
- Line of credit (LOC)
- Monthly payment options
- Any combination of the above (for example, establishing a LOC while receiving a monthly payment)
Since the focus of this article on comparing the standard HELOC to the HECM LOC, that is the option that I will be discussing here today.
It should also be noted that in order to get a HECM LOC, the homeowner must have enough equity. There are no HECM 2nd mortgages. Any existing loan on the home must be paid in full, from the proceeds of the HECM loan. After this loan is paid off, any amount left over, can be placed into the HECM LOC allowing the homeowner to draw from it any time in the future.
If there is not enough equity to pay off the existing loan, the homeowner will ether have to pay the difference, or not get the HECM. In this case, if the homeowner brings the cash to closing to pay the difference, all of the proceeds from the HECM are being used towards paying off the loan, so there are no funds left over to establish a HECM LOC. The main benefit for someone doing this is to eliminate the principal and interest portion of their mortgage payment.
HECM LOC & HELOC Similarities:
The HECM and the HELOC are different ways to achieve the same result: converting equity in your home into cash that you can spend. Although they go about achieving this goal in very different ways, I first want to touch on the ways they are the same.
- Both loans convert home equity into easily accessible funds that can be used as needed.
- The homeowner is only charged interest on funds that are actually withdrawn.
- The interest charged is adjustable based on a variable rate tied to an index. HELOC’s typically use the Wall Street Journal Prime Rate and HEMC’s use the One-Year US Treasury Index.
- The home stays in the homeowners’ name on both loan programs
HECM LOC & HELOC Differences:
Both programs have positive and negative features about them. I want to make it clear that while I have recommended people to get a HELOC over a HECM in the past, as much as I try to be a neutral party in this article, I have been a reverse mortgage professional for almost 20 years. I am sure that I am biased towards the HECM program, even if I am not consciously aware of it.
a. Very low upfront costs.
b. Can maintain a zero balance and have no payments.
c. Interest only payments on balance used.
d. Can be used as a second mortgage (no not need to payoff the first mortgage).
a. Limited accessibility of draw period (typically 10, but sometimes 20 year draw periods).
b. Payments can increase with increases in loan balance and interest rate.
c. Payment will increase to interest and principal when the draw period ends.
d. Homeowners must requalify to extend the draw period.
e. The initial LOC amount remains fixed (cannot increase without requalifying).
f. LOC can be reduced or closed out by the lender if the value of the home decreases.
HECM LOC Positives
a. No required monthly payment no matter how large the balance owed grows. However, the homeowner can make payments to reduce the balance if they choose. Any funds paid into the loan balance are placed into the LOC for future use.
b. Flexible pay out allows the homeowners to take unused funds in multiple ways. Can set up a monthly payment in the future where the lender deposits funds into the homeowners bank on a regular basis.
c. Unused funds in the LOC grow over time giving the borrowers access to additional equity in the future without having to requalify to increase the LOC.
d. LOC can never be reduced or closed out as long as the homeowners continue to meet their loan obligations. *
e. HECM loans are 100% non-recourse. The homeowners, the estate or the heirs, can never be held liable for any monies owed beyond the value of the home.
f. Federal Housing Administration (FHA) insured loan. **
HECM LOC Negatives
a. Higher closing costs. This is mainly due to the fact that it is an FHA loan which requires an Initial Mortgage Insurance Premium (IMIP) charge of 2.0% of the value of the home.
b. Ongoing mortgage insurance premium (MIP) of 0.5% of the loan balance. This charge does not have to be paid out by the homeowner, however it is charged, and added to the balance on a monthly basis.
c. Negative amortization. Since no payment is required on HECM loans, but the interest and mortgage insurance are still charged, these charges are added to the loan balance, and they increase the amount owned at the end of the loan.
Below is a simple chart to compare the differences. It is not as complete as what I have above, but it is still a good guide:
Please feel free to contact me with any questions about this article or any other questions about reverse mortgages.
Bruce E. Simmons, CRMP
Reverse Mortgage Manager
American Liberty Mortgage, Inc.
1932 W 33rd Ave
Denver, CO 80211
Office: (303) 458-3778
Cell: (303) 513-2748 E-mail: email@example.com Web-Site: www.reversemortgageradio.net
*In order to keep the HECM LOC in place, the homeowner must meet their continuing obligation which include living in the home as their primary residence, paying property taxes, homeowners insurance, HOA dues and any other standard obligations in their city county and state.
**This material has not been reviewed, approved or issued by HUD, FHA or any government agency. The company is not affiliated with or acting on behalf of or at the direction of HUD/FHA or any other government agency.