Some people, near or in retirement, attempt to use a HELOC (home equity line of credit) on their home as a way to access the stored-up equity in their home. What these people have discovered is that the majority of their wealth is stuck in their home. While they are right about where their wealth is and the need to access it during retirement, they are wrong about the tool they are using. They don’t fully understand how a HELOC could hurt them or of a better alternative. The following pages explain how most HELOCs works, why they can be dangerous and an alternative that is much safer.
When people use a HELOC to access the trapped wealth in their home for retirement, they are really attempting to create their own type of “Reverse Mortgage.” These people have recognized the fact that most of their wealth is trapped in the equity of their home and are making the right decision to use it, but unfortunately they are choosing a potentially dangerous way to access this wealth. While their intentions are good, choosing to use a HELOC as a way to access the trapped equity in your home exposes the homeowner to some very significant risks that can easily be avoided by using the Reverse Mortgage. In order to fully understand the risks associated with HELOCs lets review how they work and their contractual terms compared to the Reverse Mortgage.
How a HELOC Works
A HELOC will initially grant you an amount that you may borrow against your home (providing that you have the income and credit to qualify). This is the same as a Reverse Mortgage. However, few people realize that the fine print in all HELOCs allows the bank to revoke your unused credit line at any time and without notice (many people learned this the hard way when their bank took away the line of credit at the worst possible time – right when they needed it during the last financial downturn!). This can easily leave you financially “stranded” right when you may need this money the most. A Reverse Mortgage (and its corresponding line of credit or monthly distributions), once put into place cannot be revoked due to changes in home values, economic conditions or other events*. This means that a Reverse is contractually guaranteed to be there when you need it: the lender cannot revoke it or change the terms of a Reverse Mortgage like they can on a HELOC (yet you can still pay it off or sell the home any time you want). You remain in control and all decisions remain with you, as you still own your home 100%.
HELOCs Require a Monthly Payment –or Face Foreclosure
The second area that makes HELOC much more dangerous than a Reverse Mortgage is that they always require a monthly payment, while a Reverse Mortgage never requires a monthly payment. All HELOCs usually start out with a minimum payment of interest only. This creates an extra burden as well. Let’s say you decide that you need an extra $1,000 per month to make financial ends meet. If you used a HELOC, the first month you would take your $1,000. However, on the second month you would need to take $1,000 for yourself and an additional $100 to make the minimum payment on the current balance from the previous month. Each month as you borrow more and your total balance owed grows you will need to take a higher additional amount to pay the increasing monthly payment (your minimum payment increases each month based upon your balance). This will only work until you come to the end of your HELOC credit limit, or until the bank revokes your unused limit. When this happens, you have no more access to the HELOC, but still have a payment due and may have no financial means to pay it. You are now financially “painted into a corner” and are at the very real risk of losing your home. Because the Reverse Mortgage never requires a monthly payment you completely avoid these risks.
While you could completely use up your Reverse Mortgage credit line and have no more money available the same as you could with a HELOC, the big difference is that while you may not have access to any money under either method, the HELOC will always demand a monthly payment or begin foreclosure while the Reverse Mortgage will never require a monthly payment and therefore you do not risk foreclosure or losing your home for lack of being able to pay a monthly mortgage payment as you do with a HELOC. This makes the Reverse Mortgage a much safer choice. If the above reasons to choose a Reverse Mortgage over a HELOC are not enough, continue to read as you will find a HELOC only gets worse….
HELOC Required Payment Will Jump Significantly
The next area of concern with a HELOC is the required monthly payments after the initial interest-only period. After the initial interest only period of (usually) 5-10 years, the HELOC will switch from interest-only to amortized payment where you are now required to pay the borrowed amount back over time, (usually the next 15-20 years). It is also important to note that your access to your HELOC is now over (you have no more access to borrow any more money). Let’s assume you have $200,000 balance on your HELOC and have been paying interest only payments based on an interest rate of 4%. This would have given you interest only payments of only $667 per month; not too bad especially if you were able to obtain the monthly payment from the HELOC itself. However, when your HELOC switches to amortized payments, even at the same interest rate of 4% your payment the very next month will be $1,212 if amortized over the next 20 years, and $1,479 if amortized over 15 years.
Take a careful look at what has happened. Your monthly payment has doubled or more than doubled AND you no longer have access to obtain the monthly payment from the HELOC that you had just the previous month. With no access to your equity and a dramatic increase in your monthly mortgage payment, clearly this strategy has now put you in a disastrous position and may very well end up with you losing your home due to not being able to meet those now much higher monthly payments. Again, the Reverse Mortgage avoids this pitfall because it does not require a monthly payment. Keep in mind that the above scenario was also using a “best case scenario” of a continued low interest rate environment. Let’s now take a look at what a change in rates may do to you.
All HELOCs are adjustable and all or nearly all of them are based on prime rate. While prime has been very low over the last few years, it can be a fast moving index and has increased significantly in the past when the Feds decide to change it. Because rates are at all-time lows and prime as of this writing is at 3.25%, the only way it really has any room to move is UP. Historically when the Feds decide to raise prime they usually do so fairly aggressively. It would not be uncommon to see them move it up 2-3% in the first year of change alone. Let’s look at what just a 2% increase would do to your payment when coupled with a change from interest only to amortized at the same time. Again, assume your HELOC has been at 4% interest only (prime + .75%) and your interest-only payment on a $200,000 balance was only $667. Now consider if prime increases 2% your rate now moves to 6% and if the lender now amortizes it over 20 years, your new monthly payment is now $1,433 and on a 15 year is would be $1,688. Your payment is now 2 – 2.5 times higher than where it was previously and again, your access to your line has been closed down. If this is not bad enough, once the feds decide to raise prime they will usually continue with this increasing strategy for several years, so it could very well just be the beginning of very high payments to come.
Again, the Reverse Mortgage does not require monthly payments and therefore you will never have to worry about an increase in a monthly payment. This fact protects you and your home from foreclosure and is a huge safety feature of the Reverse Mortgage and not available from any other type of mortgage product out there.
The Fed’s have increased prime in December of 2016 and have stated more increases will be forth coming during 2017. Please take their warning seriously and move yourself to a safer alternative and soon as possible.
Increased financial pressure with the loss of a spouse
If you are married and comfortable making your HELOC payment today, you may still be at risk when your spouse passes. This happens because the surviving spouse (usually the woman, but applies to the man also) will experience a significant reduction in monthly income. This is due to the loss of the lowest Social Securities, possible loss of pension income and/or part time work while still retaining all of the daily expenses of living. Therefore, I urge you to consider how you or your spouse would survive with your current bills, but with this loss of income. It is quite obvious, that by eliminating your monthly mortgage payment on both the first and any HELOC or 2nd mortgage would put both you and your spouse in the very best financial position possible for retirement today and well into the future, no matter what lays ahead for either of you.
HELOCs Have Very High Cap Rates
Lastly, there is one more area of concern with HELOCs being used to access your equity during retirement: the overall interest rate cap. The “rate cap” is the maximum amount or rate that you can be charged at any time over the life of the loan. For most HELOCs, this is usually between 18-22% (quite high by any standard). Using the same example from above, if you have a $200,000 balance, your interest-only payment would be $3,000 and a 20 year amortized payment would be $3,087. If you compare that to where rates and the same payments are today ($667 for interest only) you can clearly see that a HELOC exposes you to great financial risk, especially when rates are on the move upward which is the current trend.
In comparing the HELOC to the adjustable Reverse Mortgage, the Reverse Mortgage total life caps today are in the 8%-14% range. This significantly lowers your risk of high charges and may result in far lower interest charges over time.
You Are On The Hook With A HELOC (but not on the Reverse Mortgage)
You must personally guarantee any amount you borrow on a HELOC. This means that no matter what happens, you (or your heirs) must pay back the full amount borrowed on the HELOC (plus interest) even if your home has dropped in value. This could create a very damaging event and cause significant financial pain for you or your heirs.
The Reverse Mortgage is a “No Recourse loan” and specifically guarantees that neither you nor your heirs are responsible for any shortfall. On a Reverse Mortgage, the home is the sole source or repayment. If there is a shortfall (the home is worth less than the amount borrowed), the lender takes the loss and does not come after you or your heirs for the difference: one more reason why the Reverse Mortgage is the far safer option.
The Reverse Mortgage Credit Line can GROW Over Time (the HELOC does not)
A unique and fantastic feature of the Reverse Mortgage is that “the unused credit line ‘grows’ at whatever rates are in effect”. For example; if you had a $200,000 available Reverse Mortgage credit line and did not use it during the first year, the following year you would have $208,000 available to use (assuming rates were at 4%). Under the same scenario, if unused for 5 years, the amount available would be $244,199. This is an incredible guaranteed feature not found on any other loan product (I have an entire report on this topic alone –feel free to request it). This acts as a tremendous tool/safeguard to help keep up with the higher cost of goods and services in the future as well and is infinitely safer than the HELOC (where the bank can take away your unused balance).
HELOCs can be a useful financial tool for many individuals: those who need very short-term loans and have the means to pay them back quickly, or those who can handle very significant increases in the monthly payment without jeopardizing their ability to meet all of their financial obligations. However, when it comes to retirement and retirement planning, the average individual will be FAR safer and much more secure by choosing a properly structured Reverse Mortgage to meet their financial needs during retirement rather than to structure their own, makeshift type of reverse by using a HELOC.
How a Reverse Mortgage is Similar to a HELOC
I have explained how and why the Reverse Mortgage is much preferred over a HELOC during retirement, but now let’s look at how they are similar:
Under both loan products you still own your home 100% and still pass the home on to your heirs when you pass away. Both charge you interest each month and both provide you with a monthly statement each month. You are required to pay a monthly payment on the HELOC (and in trouble if you don’t) and you MAY pay a payment on the Reverse Mortgage if you wish, but are not required to do so (they simply keep track of what you owe). Upon your death, the home is still part of your estate and transfers to your heirs as you wish. Under a HELOC your heirs must continue to pay the HELOC (or face foreclosure). Under the Reverse Mortgage your heir must settle up on the outstanding balance. This may be by refinancing, selling or cash from your estate or from them. Under both circumstances, the home now belongs to the heirs and they are free to do with it as they see fit or as directed to them by your trust.
I hope that you have found value in this report on creating a safer retirement.
At last count there were 36 different versions of the federally insured Reverse Mortgage program available. It is very important that you speak to an expert in this arena in order to get advice on which of the Reverse options would suit you best for your particular circumstances and to produce the very best outcome for both you and your spouse (if you have one).
I would be pleased to answer each and every question of may have (no question is too small or too silly to ask!) in order to ensure that all your questions are answered, you know all your options and are able to choose the very best program to suit your particular needs.
Sincerely,
Bryon Pyle
Pres.
About the author.
Since graduating with a business degree in Finance in 1981, Bryon Pyle has been involved in mortgage lending and has focused on helping individuals improve their cash flow and obtain the American dream, homeownership. From helping thousands and thousands of clients, Bryon has been able to see how the bedrock of America handles their finances. Alarmingly, most Americans do themselves a tremendous disservice by making a series of poor choices. Most Americans arrive at retirement age with a severely underfunded retirement plan and no time left to redirect themselve’s, yet continue to make poor or uninformed retirement choices. Approx. 62% take Social Security before they reach full retirement age. Many pay too much in income taxes on their retirement savings due to poor planning. Too few know or understand how to maximize what they have to help provide the highest amount of access to cash/cash flow while minimizing their taxes and other outflows. Our goal at Crossmark Financial is to provide safe, well thought-out solutions and support that improves cash flow and provides greater access to cash in the safest manner possible. We have written extensively along these topics and encourage clients and advisors like to obtain and read our reports in the hopes that together we can help clients’ improve their financial retirement well-being.
