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].
