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Four in five seniors own their own homes and one in three owns that home outright. Here's the blunt question: should they use home equity lines of credit (aka HELOCs) to help handle cost-of-living expenses in retirement and emergencies such as a roof repair, major dental work or a big hospital bill? Or is a reverse mortgage a safer way?
The median household approaching retirement has $10,000 to $20,000 saved. Over 40% have nothing, not a penny.
That's why eyes are switching to the house. Shouldn't a senior use a reverse mortgage - a so-called HECM (home equity conversion mortgage) - to put cash in his hands? Maybe. But other experts point to the possible advantages of a HELOC.
There even are special cases where tapping into a HELOC is a no brainer. It's just obviously the smart move.
Nationally, the average home sales price is around $186,000. Regional variations are enormous. In Hawaii, the average home sells for around $547,000. In Florida it's about $175,000. Either way, though, that puts a chunk of change within a senior's reach in the event of an emergency.
So, why not an HECM? For some seniors, it provides a steady income stream. For others, as need arises, it can serve as a kind of HELOC substitute -- that is, supplying cash to help get through emergencies. What's not to like about HECMs? Two things. First, when all is done, ownership of the home passes to the third-party lender, that is, it does not wind up with heirs which is the dream of many seniors. The other reason: HECMs are "very expensive," said Casey Fleming, a Northern California based mortgage expert and author of The Loan Guide. Loan origination fees along with mortgage insurance premiums frequently propel reverse mortgage costs over $5,000, sometimes above $10,000.
There's a push to lower costs - led by the U.S. Consumer Financial Protection Bureau along with some lenders. But the consistent grumble is that HECMs are pricey, even though all fees generally come out of the borrowings, that is, not directly out of the senior's pocket.
HELOCs are dramatically cheaper. HELOCs - which often will lend up to 80% of a home's equity, possibly more - come with low interest rates, nowadays under 5% APR. There may be an introductory rate, perhaps 1% for the first six or twelve months. There may also be no closing costs, possibly no loan origination fees.
Another plus of a HELOC, said Jamie Hopkins, co-director of the New York Life Center for Retirement Income at The American College of Financial Services in Bryn Mawr, Pa., is that banks often will write one on properties that wouldn't qualify for a HECM such as a vacation home.
And then there are those special cases where a HELOC is the plainly inspired move. Pete Lang, president of Lang Capital in Hilton Head, S.C., gave a for instance. Say a senior needs $25,000 for a new roof, right now, and doesn't have the cash on hand. He has tax advantaged investments - say an IRA or a 401(k) - but pulling that money out triggers immediate tax consequences. Not so with a HELOC. "Pull money from an investment and you only get two-thirds," said Lang. That's because the IRS will grab a chunk. "With a HELOC you get 100%," Lang added.
What's the catch? There are two big drawbacks to a HELOC, said multiple experts. The first is that many seniors just will not qualify for a HELOC, because they don't have sufficient income or cashflow. A bank wants to believe a borrower has the income to successfully service a loan before issuing it and for many seniors, that's a problem.
Problem 2: in a worst case scenario, a senior can lose his home when a HELOC goes bad. Foreclosure is an option for the lender, and if the note is not being repaid, the lender will use it.
"In most situations, setting up a reverse mortgage line of credit will be more expensive because it also comes with more consumer protections than does a HELOC," elaborated Hopkins. An HECM is designed with seniors in mind. A HELOC isn't.
That's why a reverse mortgage - expensive as it is - may be the better, safer option for a lot of seniors. Foreclosure won't happen because - by its very design - an HECM is paid off when the senior dies or moves out of the home. In special cases, a lender may foreclose on a HECM if a senior is not paying property taxes or homeowner's insurance. But, mainly, a reverse mortgage - expensive as it may be - exposes a senior to no risks while also providing an income stream.
Which is the better tool, an HECM or a HELOC? There is no easy answer. Answers are case by case, and that's why seniors with questions are advised to consult with professionals who specialize in HECMs and HELOCs.
This article is commentary by an independent contributor. At the time of publication, the author held TK positions in the stocks mentioned.