Reverse Mortgage (HECM) vs Home Equity Line of Credit (HELOC)

An excellent question from one of our readers...

Dear All Reverse Mortgage,
The financial collapse of 2008 took about 40% of my retirement assets, and although there has been a nice recovery in 2009 and 2010 I am modestly in doubt about my remaining liquid assets to outlive me if both me and my wife live to be 95ish!!

Hence my interest in securing a reverse mortgage more as a form of later years insurance than as a requirement of current survival. My wife (68) and I purchased a house in 2007 in Florida where we currently reside and lead extremely active and healthy lives. We paid $675,000 for this house in 2007 and I roughly assume it is currently worth not less than $500,000 after the deflation of the past three years. We paid cash for the property and have no outstanding mortgage balance on it although we do have a $250,000 never used equity line of credit as a form of insurance.

Over the next several years I expect to invest roughly $100,000 in improvements such as bathrooms, kitchen, roof and exterior pool landscaping. I have the cash to fund all of these improvements and no need for any form of financing to fund them. However, having said that, my liquid assets will diminish at a pace greater than "plan" over the next 5 years or so if I do use cash available. Also, if I use IRA funds to finance improvements I will have to pay taxes at the marginal rate of 20-30% on any such distributions. I would rather not take distributions in excess of the so called IRS "required minimum annual distribution".

One alternative I have to finance such improvements would be to draw on the heretofore unused equity line of credit of $250,000. The rate is under prime but I'm unclear on the cash flow characteristics of using that line for financing improvements. The proceeds, of course would be tax free, and the interest paid would be tax deductible to a principal limit of about $100,000.

A second alternative would be to take a reverse mortgage for about $200,000 or higher NOW and let it sit idle for a few years until and if I decide we should use it. If I did take a reverse mortgage now, I would pay the fees out of cash and not take an advance on the Reverse mortgage. The trigger as to whether or not I take this course of action now or delay it for a few years is the effect of current versus future interest rates on Reverse Mortgages. So... finally I come to the questions!!

If I were to take a Reverse Mortgage:

 1.  What total closing costs might I expect on a loan in the amount of $200-250K?

 2.  If I took a loan NOW for, say $200,000 and did not draw on it for, say, three to five years or longer, would the amount available to be drawn under the loan increase over those years?

 3.  Since interest rates are quite low right now and only reasonably expected to rise over the next few years, would it make sense to take a loan now in order to achieve the lowest "cap" on a monthly variable rate in the future if rates rose very substantially? Keep in mind that I would not expect to draw on the Reverse Mortgage line of credit for a few years or more and would pay all closing fees out of pocket.

Alternatively, I could postpone the decision until the need arose in a few years, but at that point the base rate might be higher and the consequent "cap" or maximum rate would assumedly be higher as well.

 4.  What are currently available terms on variable rates for Reverse Mortgages and what are the "cap" or maximum rates based on currently closing loans?

 5.  Are you licensed to broker or bank an HECM in Florida?
Well, thanks for bearing with me on this explanation and inquiry. I like your company's marketing approach and look forward to your response.

-Bill

 

Bill,
These are all excellent questions and I am afraid to answer them well is going to take a bit of time and explanation so hang with me on this!  Firstly, I understand your concerns.  Your existing Home Equity Line of Credit (HELOC) is by far the least expensive option for you to keep since you already have the loan in place and there would be no additional fees to keep it there.  I also understand your concerns with a HELOC as many borrowers have seen their HELOC's frozen over the last several years and what they thought they had for insurance (as you put it) was not available when the time came that they really needed it. 

Let's start with some mechanics.  A reverse mortgage does not work like a forward mortgage in that you don't apply for a loan of $200,000 to $250,000, you are given an eligibility which is affected by the property value, the HUD lending limit, borrower's ages and interest rates.  In 2009, HUD limits received a temporary increase which was extended into 2010 to a maximum lending limit of $625,500 for the Home Equity Conversion Mortgage (HECM or "Heck-um") reverse mortgage program.  The limit prior to the temporary increase was $417,000.  Since I know your ages are 68, if I just assume that you just turned 68 and are not ready to turn 69 in the next 6 months I can run your eligibility numbers from that using today's information.

You would have to take an adjustable rate mortgage, the fixed rate HECM option requires that you take a lump sum of all your available funds up front.  Also, living in Florida, you live in one of the higher states for other closing costs due to the Intangible Tax and the state taxes which alone would total about $4,125.00 on this transaction.  So to answer your first question, the total fees would run anywhere from $20,000 to $22,000 depending on the origination fee. 

The maximum origination fee that could be charged is $6,000 and the originator can discount this fee.  You can pay these fees up front so that you are not accruing interest on any balance; however, every reverse mortgage also has a monthly servicing fee of $25 - $35 (there may soon be others available) that would be added to the balance monthly.  This amount could also be paid monthly or annually if you did not want to allow it to accrue for any reason.  Reverse mortgages never have any prepayment penalties so you can prepay any or all of your mortgage at any time. (You may also reference this complete list of Reverse Mortgage Fees)

The amount of available funds for your reverse mortgage under today's rates and fees with today's interest rates would be $240,000 or $262,000 +/- if you paid the fees out of pocket.  The unused portions of the funds do grow as your eligibility grows.  In other words, to answer your question, if you did not use your line of credit for the first five years, that line would grow to somewhere between $330,000 and $350,000.  When you apply, we or any other originator can give you a graph indicating the growth of the credit line if left unused.

Your third question is an excellent one and one which actually has several ramifications which no one can tell you for sure which way you should go.  I can only tell you what can happen and let you make an informed decision.  There is a 10% rate cap on the adjustable rate. 

Another thing to consider is the current margin.  Margins have been reasonably stable in recent months but over the past year or two have been rising steadily.  The margin is added to the index (mostly the 1 month LIBOR) to determine the rate at which you will accrue interest on your loan.  If the margin rises from its current level of 2.25% - 3.0% to a higher level in the future, this will affect the interest you accrue and will negatively affect the amount for which you will qualify under the program. 

Future interest rate increases would mean that if you chose to obtain your reverse mortgage at that time you will have a higher cap (meaning if the rates continue to rise, you could have an even higher rate, but that would take a really high increase) and you would be eligible for less money under the program. All HECM's have the same 10% lifetime cap but margins do vary between originators so you should definitely watch to make sure you don't pay above 2.5% on your margin.  Some lenders are charging 3% or more and I would not advise anyone to take a margin that high at this time.  All Reverse Mortgage is a licensed broker in Florida and we do offer the 2.5% margin.

There are a couple of things you did not ask but I feel as though I should add them at this time.  Please remember that this is not intended to try to "scare you" into applying for a reverse mortgage and it is not my intent to try to hurry you into anything you might not otherwise do, but I feel as though I should tell you everything we currently know. In October of 2009, HUD lowered the eligibility for HECM borrowers by about 10%.  Meaning, prior to the decrease, you would have received roughly another $26,000 in eligibility.  There is talk that the program may receive another cut in October of 2010. 

There has also been some discussion that HUD may raise the mortgage insurance premiums this October.  Of the $20,000 - $22,000 in fees I said your HECM would cost you today, $10,000 alone is the up-front mortgage insurance premium.  There is also a premium of .50% on the unpaid principal added to the balance monthly that is due to HUD on every HECM loan. 

This figure may be going up the future as well.  Finally, unless the temporary increase is again extended, the eligible Principal Limit will decrease to $417,000 on October 1, 2010 and your eligibility will be based on $417,000 - not the value of $500,000.  Therefore, if you do choose to wait and if the principal limits come back down, you would be eligible for less money.  If the limits come back down and HUD drops the eligibility as is currently being discussed, you would lose even more in eligibility.  If rates and or margins go up, limits come down and HUD drops the eligibility, well, you understand where I'm going with this!

Please let me stress again that we do not know for sure that the HUD fees will increase nor do we know if Congress will again extend the temporary limit increase, but I would be remiss if I did not let you know that these things are currently being discussed.  If the $625,500 limits are extended, HUD does not further decrease Principal Limits Factors or even goes back to former Limit Factors prior to their decrease in October of 2009 and rates or margins go down, you could actually be eligible for more funds under the program. 

It all depends on what you think will happen in the future and where you think rates will go.  Your basic premise was that you felt rates were probably going to rise in the future and unfortunately, I tend to agree.  If we are correct and if all the recent changes to the HECM program continue on their current course, then there will never be a better opportunity than now for a reverse mortgage from the standpoint of lowest rates and greatest eligibility. 

But as I stated when I first started, no one can predict the future and all I can do is give you the information we have and let you make an informed decision.  A HECM is an expensive loan and only you can decide if the costs are worth it to put the loan in place at this time knowing the line can never be frozen and will grow over time.