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A message from NAMB Executive Vice President/CEO Michael J. Nizankiewicz, PhD, CAE

Jun 11, 2006

Forward on reverse: What the Wall Street Journal failed to tell readers about HELOCs vs. HECMsAtare E. Agbamu, CRMSHELOCs,HECMs One of my favorite columns in the business world's pre-eminent daily business newspaper is "Getting Going" by Jonathan Clements. Clements dispenses generic personal finance advice. He is one of the best in the business. In a piece, titled "Five Strategies for Helping Your Parents—and Getting More from Their Estate" (Wall Street Journal, Jan. 18), Clements gave some advice on home equity lines of credit (HELOCs) versus home equity conversion mortgages (HECMs) that illustrated the dangers of giving and taking generic financial advice from otherwise very good financial generalists. In strategy number four, "Taking Credit," here is Clements' sage advice: "Later in retirement, if the parents start running short of money, they might be tempted to tap into their home's value through a reverse mortgage. But, these loans, which usually don't have to be repaid until after the parents die, can involve closing costs of as much as $20,000," he wrote. "To avoid that eye-popping expense and preserve money for their children, the parents could opt instead for a home equity line of credit, which will also allow them to borrow against their home's value, but should cost little or nothing to set up. There is, however, risk involved. Unlike a reverse mortgage, the parents will have to make regular repayments on the credit line during their lifetime. They could keep up those repayments for a bunch of years, simply by drawing down the credit line even further. But, eventually, the credit line might be tapped out—and the parents could find themselves in a nasty cash crunch. Sounds scary? Maybe, if it gets to that point, the children could commit to making the minimum payments on the credit line." To his credit, Clements mentioned the risk of a cash crunch. The cash squeeze comes from the monthly repayment obligation of a HELOC. In addition to their monthly cash draw for living expenses, the repayment obligation will compel Clements' HELOC borrowers to use principal to pay principal. With variable interest rates on HELOCs, this strategy can quickly liquidate the borrower's home equity. HECMs (aka reverse mortgages) have no repayment requirements for as long as the borrowers live in their home. So, for "little or nothing to set up," those who follow the Wall Street Journal's strategy could end up not only rapidly running through their home equity, but also confiscating extra cash from their children to pay the lender. Let's take a moment to review some relevant questions: • What happens if the kids are unable to make the minimum payment for their parents? • What is the cost of the minimum payments to the kids? • What if the parents live for 25 more years? • Why should the kids commit to transferring minimum payments to a lender, when they could be using those minimum payments to shore up their own retirement portfolios? • Why should the kids follow a strategy that guarantees loss of their inheritance, while putting their parents on the streets? If the Wall Street Journal were some provincial business paper and Jonathan Clements were an upstart financial columnist, I would not bother to write this response. The Wall Street Journal is the king of business dailies, and Clements is a respected and influential columnist. I personally enjoy reading his fine column. But, I believe his strategy number four is ill-advised and could hurt those who follow it. Here are my reasons: • Monthly repayments. The HECM borrowers has no monthly repayments to make; the HELOC borrowers must make monthly repayments. If they fail to make payments, they lose their home, their shelter and their place. • Non-recourse home loans. HECMs and all reverse mortgages are non-recourse loans. The parents' children and heirs are not liable for repayment. The lender is legally forbidden from looking beyond the property to recoup any loss it may suffer in a reverse mortgage transaction. Can you put a dollar sign on the value of this protection for an older adult? The HELOC loan does not offer this vital protection. If the home securing the HELOC falls in value below the cash the lender advances the parents, the parents could lose more than their home. • Asset protection. HECMs and reverse mortgages guarantee borrowers against losing their homes, even if they exhaust their available equity, provided that they pay their property taxes and homeowners insurance. HELOCs do not offer similar structural legal guarantees. • Consumer education. HECMs and reverse mortgages mandate consumer education from trained and certified reverse mortgage counselors before a borrower can get a reverse mortgage. HELOC borrowers are on their own on a decision that could cost them their home. • Little-cost to zero-cost reverse mortgages. Not all reverse mortgages come with an eye-popping entry fee. There are proprietary reverse mortgages with little to no set-up fee. HELOCs have a little set-up fee. • Full disclosure. HECM and reverse mortgage lenders are required to make Total Annual Loan Cost (TALC) disclosures over the projected life of the loan. In its rigor, the TALC disclosure has no parallel in the world of HELOCs and traditional forward mortgages. All costs, including servicing costs for the life of a reverse mortgage, must be disclosed to the borrower. HELOCs hide servicing costs in the interest rates. The ubiquitous APR does not tell the entire story on the hidden costs of HELOCs. • Lower long-term costs. It is a fact that the longer you keep a HECM loan, the lower the TALC. With HELOCs, the opposite is true. For folks already running short of money, qualifying for HELOCs could be tough because they must show lenders that they have sufficient income to pay them back. While lack of income may not prevent them from getting a HELOC loan today because of the availability of stated income or no income/no documentation programs, it would exact a heavy price—higher interest rates relative to tame reverse mortgage rates. So, for "little or nothing to set up," Clements' HELOC borrowers could be saddled with higher interest rates (costs), higher monthly repayments (headaches), faster depletion of their home equity (heartburns) and a quicker march into default and foreclosure (mortal terror in a season of respite). It is penny-wise and pound-foolish. Yes, HECMs and some reverse mortgages can be expensive to set up, and it is tempting to focus on the costs and ignore the incomparable benefits. The real question should be, "For the right borrower, is it worth it?" On a cost-value basis, my money is on HECMs and reverse mortgages. Think reverse. Move forward! Atare Agbamu, CRMS is president of ThinkReverse LLC, a reverse mortgage training and consulting firm based in the Twin Cities and a consultant with Credo Mortgage. His clients include LeaderOne Financial Corporation and the Nevada Federal Credit Union, among others. Atare is regarded as an emerging authority on reverse mortgages and he advises financial professionals, institutions and families across America. His interviews are Webcast on MortgageMag Live! Atare has been featured in National Mortgage News, Home Equity Wire and Origination News. He can be reached by phone at (651) 389-1105 or e-mail [email protected].
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