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September 1, 2015
Let’s face it, most of us cannot predict the future. Otherwise, we would probably be set for life financially. The stock market is volatile and the housing market is sensitive to economic turmoil. The cost of living continues to increase while government benefit adjustments are too small or non-existent. Most of us look to our home equity as a cushion for improving our situations in tough times, but that decision should take careful consideration.
A Reverse Mortgage Line of Credit Can Be a Great Option…
When comparing a Reverse Mortgage Line of Credit (RM LOC) to a standard Home Equity Line of Credit (HELOC), it’s important to put the numbers into perspective.
Many people don’t understand critical differences which could cause big impacts downstream. I am not talking about the quick estimates you receive from an online calculator, but an actual written proposal that is specific to your situation and your unique property.
You should consider the cost of the different loans over the anticipated life of the loan and the flexibility offered by the different solutions. When it comes to the different line of credit products there are many key points you will want to consider.
At first glance, getting a HELOC seems to make better financial sense. With a HELOC the closing costs can be minimal. Closing costs with a RM LOC however are more extensive and include an origination fee, appraisal, counseling certificate and potentially upfront Mortgage Insurance Premium. Your closing costs will depend on how much upfront you draw, but often times you can negotiate your origination fee and may even get the lender to pay for your appraisal. This is why it is important to compare offers between reputable lenders.
When putting RM LOC closing costs into perspective it is important to look at the big picture. A traditional HELOC may be subject to renewal, or even revoked depending on your financial situation. A RM LOC is designed to last for the remainder of your life.
Dividing the total cost of closing a RM LOC by the years you anticipate remaining in your home can quickly illustrate how inexpensive the one time closing costs can be over the long term. For example if you think $8,000 it seems like a lot, spread that over another 15 years and you are looking at about $530 a year. Since these closing costs are financed you don’t actually pay out of pocket for them.
Mortgage Insurance Premiums (MIP)
A Mortgage Insurance Premium (MIP) is an important mandate by the federal government to protect the lender against home values crashing, and also protects the borrower by guaranteeing that unused proceeds remain available to the borrower, should the lender run into financial trouble.
If your Loan to Value (LTV) is below 80 percent you would not be required to carry MIP with a traditional HELOC. With a RM LOC, however, you would be charged an upfront MIP depending on how you structure your initial draw, and an ongoing MIP which is tacked on to your interest rate. Your upfront MIP would be as low as .5 percent of your appraised value at closing if you do not exceed 60 percent of the amount you qualify for with a RM LOC. If you have debt obligations like an existing HELOC, first or second mortgage, or tax liens that also need to be paid off, your MIP would be as high as 2.5 percent of your appraised value at closing if you exceeded the 60 percent threshold.
You can keep this fee down if you are able to limit your initial draw to less than 60 percent of what you qualify for. You will then be able to access the remaining 40 percent one year from the date of your loan origination without being subjected to the higher MIP rate.
Paying interest on home loans is generally unavoidable. When we think back to when we first purchased our home and compare it to current market rates we get a sense of gratitude when we realize our home is hopefully worth more on the market today than when we originally bought it.
For example, if we paid $200,000 for our home 15 years ago, with an average annual appreciation of 4 percent, today our market value may be close to $360,000. Sounds like a $160,000 gain right? Not so fast!
We often forget that we have paid interest over the life of our mortgage, which technically increases the cost of acquisition. Thankfully the government lets us itemize our home mortgage interest on our tax return to soften that blow.
However, the fact remains, that when we factor interest, we have paid A LOT more for our home than the original purchase price.
With a traditional HELOC you are adding to the amount of money you pay for your home by increasing the amount you need to pay interest on. The interest rate you sign up for can be a fixed rate term loan with structured payments of principle plus interest, or an open ended line of credit with an adjustable rate and potentially interest only payments. Today’s market interest rates are guided by LIBOR and current mortgage industry standards, and can be more favorable if your credit score is good. There is always a risk that interest rates rise and cause our interest costs to increase significantly, and let’s face it, in today’s environment there is only one way for interest rates to go… UP! Reverse Mortgage LOC’s do require adjustable rates, just like an open ended HELOC.
Increasing interest rates directly affect how much you qualify for with a Reverse Mortgage. The higher the current interest rate environment, the less you qualify for.
The Monthly Payment
What if you keep putting off your knee surgery because you really need to work that part time job to make the payments on your HELOC? When we take out any loan we consider what we are comfortable paying monthly under today’s circumstances. As we all know from experience, today versus tomorrow is never stable, nor guaranteed.
With a traditional HELOC or other traditional mortgage products you don’t have the option of missing a monthly payment. Your minimum payment is required every month. If there is an unpredictable snag in our financial runway we always pay our mortgage payment first to protect the built up equity in our biggest asset, our home. Keeping up with that monthly mortgage payment may cause a strain on our other financial obligations when times get tough. This could lead to missing payments on our revolving credit cards, being late on our utilities, or even letting our health insurance lapse! Late fees and higher interest rates on our credit cards add further strain to our budgets!
With a RM LOC you can make monthly payments if you would like to, or no monthly payments at all. It’s your choice. Many people think that they can’t pay back a Reverse Mortgage. The fact is, if you have the means and want to make payments to keep that balance down you can certainly do so without any prepayment penalties. You are just not required to! This is what makes a Reverse Mortgage unique, and a RM LOC may end up providing you flexibility when you really need it most when unexpected financial issues arise.
Future Balloon Payments
An opened end HELOC may only require interest payments for the first 10 years. What happens when you have used a significant portion of that HELOC making interest only payments, and suddenly its 10 years later and you’re facing a balloon payment? Now that you’re into your 70’s on a fixed income and possibly working a part-time job, which bank can you turn to refinance that HELOC into a fixed rate product with reasonable monthly payments? Wouldn’t it be nice if you didn’t have to worry about a monthly mortgage payment?
According to Experian nearly $265 Billion of HELOC originations are due to expire over the next three years! The full impact of this is just starting to hit the housing market. These looming mortgage payments can potentially push many seniors into default and even foreclosure, thus damaging the currently recovering housing market. This will drive home values down and decrease everyone’s borrowing power.
If you have a HELOC coming due shortly, one option you might consider is refinancing your HELOC balance with a Reverse Mortgage. Putting together a plan today could save you significant dollars in the future.
Most mortgage products have seasoning requirements, meaning any proof of cash balances are required to “season” at least 3 months in your account to be considered by underwriting. There is a new stipulation to get a Reverse Mortgage that your existing mortgage related debt must also be “seasoned” at least 12 months before it can be eliminated by a Reverse Mortgage. If you plan on replacing your current HELOC with any Reverse Mortgage product, be sure that you have not gotten any cash proceeds out of your home for at least 12 months, otherwise your ability to apply for a Reverse Mortgage will be delayed until that debt meets seasoning requirements.
Access to Future Equity Reserves
With an open ended HELOC, future access to your equity is never guaranteed. The lender can reduce or revoke your line of credit at any time. The HELOC access you have is always restricted to a credit limit amount. With a RM LOC your home equity access actually grows over time! When taken as a line of credit, a Reverse Mortgage LOC grows every month by a predetermined rate which is calculated using the previous month’s available credit line and current interest rates. This RM LOC continues to grow and can even end up exceeding the market value of your home if home values turned down.
The best part (as if a line of credit guaranteed to grow every month with no monthly mortgage payments that could potentially outgrow the market value of your home wasn’t good enough?) is that your RM LOC would never be revoked so long as you maintain your obligations as a borrower. These include keeping up your property tax and homeowners insurance payments, maintaining the home, and as long as the home remains your primary residence. The RM LOC would become due if you didn’t keep up these obligations and/or if the last borrower leaves the home.
So Which Equity Line is Best?
If you are looking for a line of credit with a lower upfront cost that is subject to renewal, or can be revoked, and are comfortable with maintaining monthly payments until the balance is paid, then a HELOC could be right for you. Keep in mind if you choose the interest only option you will be facing the loan coming to term and potential ballooning payments at some point.
If you like the idea of having access to your home equity until you leave the home, with a line of credit that grows every month indefinitely, and no obligation of a monthly mortgage payment, then a RM LOC could be the best fit for you!
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