I think that HELOC’s are generally riskier than a reverse mortgage. Here’s why…
First and foremost, both HELOC and the reverse mortgage line of credit are both adjustable rate mortgages. The difference is that with the HELOC if interest rates go up your payment towards the HELOC is also going to increase. Whereas with the reverse
mortgage if interest rates go up, your monthly payment towards the reverse
mortgage doesn’t increase because there is no monthly mortgage payment required. (you still need to pay your property taxes and homeowners insurance)
HELOCs are generally typically interest only for 10 years. The issue with that is that most people will only make the interest only payment and at the end of the 10-year
period the loan will become fully amortized. Once it fully amortizes their payment
will increase significantly. This is because the loan will need to be paid back in full over the next 10 or 15 years, depending in the term of the HELOC.
There is no payment required with the reverse mortgage. (you still need to pay your property taxes and homeowners insurance) You don’t have the fear of a monthly payment increasing and becoming unaffordable.
The third issue is the more you borrow from the HELOC the higher your monthly payments will be. Think of it like a credit card. The more you charge on
the credit card the higher your monthly payments are going to be.
But with the reverse mortgage, even if you pulled out all of the money out of the reverse mortgage line of credit, your monthly mortgage payments are not going to increase because again you don’t have to make a monthly mortgage payment. (you still need to pay your property taxes and homeowners insurance)
HELOCs have a limited draw period. Typically, you can only draw for the first five years and after that point you can no longer draw from the HELOC. This could come at a time when you actually need money.
With the reverse mortgage, if you are following all the terms and conditions of your loan there is no limited draw period. If you have funds available in that line of credit on the reverse mortgage you can draw from them.
Finally, what most people don’t consider is that the HELOC could leave the spouse in a financial bind. If you and your spouse go to your bank or credit union to get a HELOC, you qualify, and the payment is manageable with a dual income. What a lot of people
don’t consider is what happens if one of you were to pass away and household
income is lost. At that point the HELOC payment could become unsustainable for the remaining spouse.
Let’s compare a HELOC vs Reverse Mortgage
I think looking at these two mortgage options side by side is really kind of eye-opening. For a lot of people the riskiness of a HELOC was probably eye-opening. Comparing them side by side is pretty awesome.
Let’s take a look at the scenario of Rick and Ginny and their comparison of the HELOC vs Reverse Mortgage
• Rick and Ginny are both 65 years old.
• They’ve got a good income of $5500 a month.
• They own their $450,000 home free and clear.
• They want to remodel their home and they need about $75 000.
• They want to compare a HELOC to a reverse mortgage.
They went down to their local credit union and got a quote. They could get a HELOC for as low as 8.99 APR and they probably would get the lowest APR because they have good credit assets, and income.
With that information I was able to put the following comparison together for them.
Option one represents the HELOC. Assuming a $450,000 value on their home. An interest rate of 8.99% APR. They qualified for a $200,000 HELOC even though they only need $75,000. I’m assuming that the credit union didn’t charge them any fees for the HELOC and then they’re going to draw $75,000 for the remodel.
These numbers are represented by bar chart on the bottom left.
The blue bar is the home value. We can see that home value is increasing because we are assuming a four percent appreciation rate.
The orange bar represents the line of credit loan balance. We can see that this loan balance is the same for the first 10 years because they’re making an interest-only payment which in this scenario is $561 a month.
Option two represents the reverse mortgage the credit line growth rate which is the expected rate plus a half a percent is 6.92% They can only borrow $165,000 which isn’t as much as the HELOC but it’s more than they need because they really only need the $75,000. There’s $18,000 of closing costs which they’re going to lump into the loan. And they’re drawing out the $75,000.
These numbers are represented by the bar chart on the bottom right.
The blue bar represents the home value.
The orange bar represents the loan balance. Over time we can see that we’re actually paying this loan balance down a little bit over time. That’s because the expected rate is lower than the HELOC interest rate.
The green bar represents the reverse mortgage line of credit. Initially we’re starting off with a $72,000 line of credit. The line of credit is growing over time. There’s two reasons this line of credit is growing.
1. First and foremost, any money that’s available in that line of credit is growing at the current interest rate plus a half a percent. In this example 6.92%. But we’re going to make the assumption that Rick and Ginny were going to make a mortgage payment on the reverse since they were going to make a payment on the HELOC anyway.
2. When they make a payment towards the reverse mortgage not only do they pay their loan balance down, but it increases their line of credit dollar for dollar.
Rick and Ginny they don’t really like this loan balance sticking around for the next 20 years of their retirement. They decide that they’re going to make a payment big enough to get the HELOC paid off in 10 years.
This next chart shows them getting the HELOC paid off in 10 years. They’d have to make a payment of $949 in order to do so.
With the reverse mortgage, in year 10 they still owe $22,000. However, they’ve got it pretty close to being paid off and if they wanted to they could continue to make payments.
In this example I’m showing them stopping making the payments in year 10 so we can see by year 15 the loan balance has increased because we are assuming they stopped making payments towards the reverse mortgage in year 10.
What’s exciting about this is the line of credit in year 10 and 15. By year 10 they are expected to have $307,000. By increasing that payment about four hundred dollars a month, they’ve increased their line of credit substantially.
By making a payment of $561, the line of credit grew to $240,000. By making a larger payment of $941, the line of credit is now $307,000 by year 10 and $434,000 by year 15.
Now, you might be thinking why on earth would you not go with the HELOC vs Reverse Mortgage, especially when you look at the fees involved with a reverse mortgage.
There are many reason to consider the reverse mortgage over the HELOC.
1. There is a limited draw period with the HELOC. Typically you can only draw for the first 5 years and then you no longer have access to any of the funds.
2. The HELOC is generally interest only for the first 10 years of the loan and then it fully amortizes. In this example, assuming interest only payments were made, the payment goes from $561 to $941.
3. What is a spouse passes away. Is the remaining spouse going to be able to afford the payment on the HELOC?
4. The reverse mortgage gives lots of financial flexibility that the HELOC does not. You can pay as much or as little as you want towards the mortgage with the reverse mortgage. (you still must pay property taxes and insurance)
5. It’s not just about needing a reverse mortgage. It’s about being proactive and having a reverse mortgage as part of an overall retirement plan.
6. You might be able to be better prepared to deal with financial shocks in the future with the reverse mortgage line of credit. Having the ability to deal with healthcare costs, long term care needs, loss of income or savings, home repairs and maintenance, can reduce the finance stress during your retirement.
Want to see how this would work for you? Give me a call at 541-897-4464. I am happy to run scenarios for you, do some forecasting, and like what you just saw, see if the reverse mortgage is a better fit vs the HELOC.
