by Daniel J Turner NMLS#1016716; Geneva Financial LLC NMLS#42056

Copyright 2020 All rights reserved. Use by written authorization only.

 

 

On pg 1.10 of the American College for Financial Services Retirement Income Certified Professional (RICP) text/outline it is made very clear to us that most Clients have 2:1 home equity to retirement savings. In my (anecdotal) observation? It’s closer to 3-5 TIMES the sum the average person saved for retirement.

Often, prudent planning urges us to suggest the Client open credit lines to have access to emergency funds, surplus cash, and other relevant uses of equity to solve problems. The “go-to” plan often suggested is a Home Equity Line of Credit (HELOC).

It is important for the Planning Professional to distinguish the various nuances and pitfalls involved with such programs, and discern the best and (ultimate consideration) must be for Client safety. While it is mentioned in the American College (ACFS) text more than a few times, the FHA HECM HELOC is not considered a “go-to” program for our consideration and integration into our practices. American College course study video presentations do not often suggest the Reverse in a first-place position, nor do they make any efforts to distinguish the difference and dangers of its more well-known brother (the “Fixed Rate FHA Reverse”) up front in their presentation to begin laying a firm foundation for understanding these plans.

To wit, most of you are unaware there is a fixed rate reverse plan; just as most of you are unaware there is an adjustable rate reverse plan. Those of you who do know this probably (for conventional lending reasons) prefer the Fixed concept over the Adjustable program. As someone who is more than familiar (and actively licensed) with the FHA and the jumbo HECM HELOC and fixed rate plans, this is concerning to me.
I will endeavor to address these on a good/bad side-by-side compare/contrast basis.

Yes, there IS a bias. I own that. But, yes, in spite of my bias? There is also a correct answer to the question, “What should I recommend for my Client regarding HELOC choices?”

There are 3 general sources of Equity lines of credit in the common lending markets today; Federal Banks, Private lenders offering proprietary programs, and the general FHA HECM HELOC program. Private HELOC programs are a small percentage and very similar to the Federal Bank plans and are kept outside this discussion.

How a Bank HELOC works

Let’s look at the typical Bank HELOC…

True HELOCS are simple interest in structure (Rule of 78) compared to (Rule of 72) conventional mortgages. This conversation refers to true HELOCS. Some lenders offer “hybrid” plans that have a future draft allowance, but include an amortized principal sum with each mandatory monthly payment. The Rule of 78 also means that interest accrues on the declining balance, and that after the monthly interest is paid, the remnant goes to direct reduction of the debt balance and immediately reduces the upcoming monthly interest charge. Interest is only charged when principal is used (borrowed), and the HELOC may stand idle for the entire term the access to equity line is available (which is 10-12 years) without any interest charges accruing. ***Note: some lenders may charge an annual fee which is nominal. They may also have an “early closing fee” within a number of years (typically -2-5 years) from the origination. This fee can be significant, and deserves to be recognized.

The loan line of credit limits are universally 80% of the debt-to-appraised value. On a $100,000 home value, an $80,000 HELOC line is possible. If there is an existing lien of $50,000? that HELOC line will be (80% of $100,000-$50,000=$30,000). Both liens are due monthly and must be paid on time regardless of whether it is one two separate Lenders.
Think of a HELOC interest table like this: P=$100,000 %=5 Term is 365 days days=$5,000/365=$13.88/day as an interest charge on the equity used. If the $100,000 balance is reduced by a payment that exceeds the interest charge, the additional sum paid will reduce the principal debt, and as a consequence, next months interest charge will be lower; the additional funds are immediately re-available for the Borrower’s use.

Due to this unique simple interest feature, there are several valid programs that use the HELOC as a depository for all monthly income, which pays down the debt by the deposit sum, and substantially reduces the interest charges. As the month continues, the HELOC is used to pay off high interest credit cards, and other relevant expenses (including food, fuel, credit payments, fees, etc.). Ongoing income continues this process. As interest costs drop, more equity is applied to principal pay-downs, and in a fraction of the years, thousands in interest charges may be saved, and a debt free status achieved, and well within the 10 year time frame of the usable equity window.
Typically, a bank HELOC is a subordinated lien on the Borrower’s mortgage. It stands behind the first lien of the primary mortgage, and any other mortgage or lien on the owner title. “Subordination” really depends upon who got in line before you did. If the home is sold, the first lien is satisfied, then any other liens, and then the subordinated HELOC is paid. For this reason, liens for HELOCS tend to be adjustable rate so that the Bank’s “interest rate risk” may be managed. Lending on a fixed rate with an open and usable line of credit may subject the Lender to serving future equity at rates below the market.
The Bank HELOC is not always a subordinated loan.

Some home owners will choose to use the HELOC as a primary financing tool to provide equity without future refi expense, and also allow the Borrower to make payments that immediately reduce the debt significantly faster than conventional lending. This rapid reduction in principal may offset the exposure of future interest rate increases by such substantial reductions in the debt.

Superior Access Tools for Borrowers to Use Equity On-Demand

The Bank HELOC typically offers very sophisticated financial access tools.
1. Checking (direct draft) account
2. Debit cards
3. Online Bill paying capabilities
4. EFT ACH wire transfers are very low cost and may be free
5. Cell phone apps and Online account access

All (or nearly all) of these services are free.

Downside of Bank HELOC’s

As nothing is perfect, there are significant exposures to Bank HELOCS that may be difficult to perceive from the Client’s view. These are elements that a great Planner would need to know to successfully advise a Client seeking to set up Equity use in retirement.

Bank HELOCs may be “callable” Typically, A Bank may “call” a HELOC if you give them reason to believe you’ve become insolvent. Death of a Spouse can reduce income (and since they know what your income is)? The death of a Borrower may result in a suspension of the loan, and conversion into a 20 year amortization to pay back the sum. This can be catastrophic to a surviving Spouse who may be depending upon access to credit to cover burial expenses, travel, final medical bills, etc.

Bank HELOCs may be suspended Not only can the lender (call in) the line of credit and/or compel an immediate 20 year amortization, Banks can suspend the line and force repayment. This was a very common occurrence in 2009-10 after the housing market collapse. While it is similar in scope to being “called”? the main difference is that it doesn’t need to be a specific condition of the borrower. If we have an economic breakdown, or if a volcano erupts, suspending the HELOC would provide an advantage to the bank of not incurring any further debt against the collateral. The bank could allow the payment plan to continue, amortize the debt to a 20 year payoff, or demand payment within a very short time (30-60 days). Since there are generally publicly known reasons why the HELOC was suspended? It could severely compromise the efforts of the Borrower to refinance to any other kind of loan except “hard money” loans (think “sharks”)

The Bank may also reduce the equity available If the value of the collateral fails for any reason, the Bank may reduce the equity available using a prescribed formula. Those who use the Line of credit for spontaneous or significant expenses (e.g. emergency income supplement during down markets, paying property taxes or medical bills, etc.) may be seriously harmed or hampered by this surprise.

Additionally, equity line originations may be fully underwritten when no existing mortgage is present. Since HELOCs (ALL HELOCS, including the FHA HECM HELOC) are exempt from “Regulation Z”? Underwriting and Loan Officer/Broker compensation may vary from typical mortgages which are subject to Regulation Z. The tendency is a higher cost of doing business than loans subject to Reg Z.

It cannot be overstated that a Bank HELOC can be a very risky loan in retirement (specifically) if the Retiree has limited financial means.

Tag-on HELOCS

However, adding a HELOC to an existing mortgage is very low cost. Since they’re not “conforming” loans, typical underwriting and expenses/costs/fees of fixed rate “Real Estate Service Provider Act” (RESPA) lending does not apply, and can be higher. The access/use is only available for 10-12 yrs from origination and then it turns into a 20 year full amortization mortgage, or refi into (and spend more equity and money) to obtain another HELOC. Income verification is required.

 

This is How Things Can Go Wrong Quickly

Choosing an appropriate “Equity Release” program is of vital importance for Borrower(s) in Retirement, as sudden death will reduce (at least) SSI and pension or annuity payouts by a large percentage of their annual income. Most loan programs won’t allow the fully amortized payment assuming 100% of the credit line is exhausted and due in the 10th year to exceed 34-45% of the income. The loss of a social security check could take the survivor from 30-35% of income to over 60%, and trigger a loan call immediately.

A forced sale is likely, especially if there is no other wealth to pay off the loan, and the ability to refinance this outside of the Bank is very unlikely as it simply may not be possible for a surviving Spouse to refinance due to income reduction at the time the HELOC is about to fully amortize. A 20 year amortization carries a substantially higher mortgage payment than a 30 year, and the Widow may have no alternative but to sell their home and find a lower cost home. If (emotionally) this takes too long, or analysis paralysis, or “He always made the financial decisions” occurs, damage to the survivors credit rating is not uncommon. Following the logical progression of thought…This can have catastrophic results.

Finally, in the event of the last Borrower’s death, heirs must continue making payments until the house is disposed of or refinanced. Making the monthly payment is expensive; NOT making the payment is substantially worse, and typically results in the Lender Bank’s legal department to eat the remaining equity that could be distributed to the Heirs. If sold at auction, the Estate may be responsible for any shortages of the equity.
Treatment while involved with Probate court (living and after decease) In the absence of a Revocable Trust/quit claim deed? The Probate Court may not allow the family to use estate resources to continue making payments to stay out of foreclosure while selling the house. This can be incredibly expensive, and the equitable distribution can be eaten alive by legal fees within months.

 

The FHA HECM HELOC (Reverse) mortgage program

Was initiated in 1987 under Reagan as a way to safely provide a conduit for seniors to use their home equity without risk or exposure to failing to meet mortgage payments, too much home, not enough income reasons.

There are 2 plans
1. The fixed rate reverse (AKA “one-and-done”) because there is no equity line, and once the loan funds, it is a closed ended loan. It must be refinanced to get more equity. It also sacrifices any HELOC equity that would normally be available at the close, and even if no HELOC equity is available? It makes no provision for any future HELOC. Refinances are extremely difficult, but not expensive. A credit is applied for any previous mortgage insurance paid, and a good Loan Officer will apply Lender paid compensation to reduce the fees to well below any other loan. TWO ratios must be met before allowing a refi of a reverse to close. This is very difficult to overcome. Due to the lac of a HELOC in the fixed rate plan? There is no way for the Borrower to manage the debt to any advantage.
For this reason, I consider the fixed rate reverse to be an unethical or uninformed choice.
2. The adjustable rate reverse-Pays out (comparably) the same percentages as the Fixed, AND it has the HELOC. For really large loans that consume all of the loan limits? If the Borrower simply sent in $100.00? They would immediately have a $100.00 HELOC.
Both are FHA/Federally insured and regulated and administered.

The adjustable rate has 2 alternative plans
1. The annual interest rate reset
2. The monthly interest rate reset

Regardless of the plan selected, or the mode of Annual or monthly rate locks? The only way to change this after the loan closes is by refinancing the Reverse with another reverse, and using the desired construct in the repeat effort.
While I can see an equalizing effect of monthly resetting to stabilize interest rate changes, the fact is that Seniors don’t like surprises. They tend to HATE “monthly” surprises. The annual reset simply has fewer moving parts and is a lot easier for them to understand. The Annual reset plan also has a cap rate that is about 3% points lower than the annual reset which (to your amazement) makes it less attractive.

2 very important concepts to grasp at this point:
1. The Credit line in the FHA Reverse HELOC will add new equity to the standing balance every day equal to the annual (or monthly) interest rate plan.
(John & Mary opened a HECM HELOC in October of 2016. Their mortgage rate was 7% on an equity line of over $136,000. At the end of their first year, the HELOC added nearly $10,000 of new equity to their account. No appraisal was required for this increase
2. The selection of an interest rate is not for the Lender; it is for the borrower to decide and choose. This is the (ahem) “reverse” of your conventions, and that is appropriate.
Since the interest rate is responsible for the velocity of the credit line growth for the future use in retirement, the correct question becomes, “Do I think I will need more equity in my future retirement? or less?” More demands a higher rate of interest; less urges a lower one.

Example

Jane purchased a HECM HELOC. She was simply getting tired of making mortgage payments. She had a son who wanted to inherit her home at some time after she passed. She took a very low interest rate so her debt would grow very slowly. When she passes on, her home will have great equity, and her son will inherit a debt refi without any required down payment. His debt to equity will be in the neighborhood of 60% (well within) conventional loan limits.

Another contrasting example

John and Mary acquired a HECM HELOC because of her recent diagnosis of Alzheimer disease. She was a marathon runner, and in top shape physically. Her hope was to be able to live her remaining years in the home where she raised her children. We turned up her interest rate, and I waived my origination to create the largest HELOC balance we could. It was growing at over 6%, and they were very happy with the prospect that the HELOC balance was non-recourse, and could be used to help manage her care when that time of need came.

FHA Mortgage Insurance Protects the Borrower(s) Rights and Interests

It is also unusual to have an insured HELOC. The FHA insurance product is unique in a Reverse mortgage because it obviously protects the Borrower; not the LENDER.
Here are some of the incredible values of the FHA (insured) HECM HELOC:
1. HECM HELOC cannot be cancelled, reduced or suspended
2. HECM HELOC lasts for 150 years from the date of the youngest Borrower’s birth
3. HECM HELOC is contractually guaranteed to add new equity (without the need of an appraisal) for the life of the Borrower’s residency in the home
4. If Equity is being used as income and both Borrowers require Long term care, the account is suspended, and the remaining equity is reserved and passed on to the Heirs. Over a YEAR is allowed for that to transpire. (conventional lending requires immediate ongoing payments to keep the home out of foreclosure; again, the reverse allows over a YEAR.)
5. The HECM HELOC is a genuinely “non-recourse” loan. No payments are required while Borrowers are alive and occupy the home.
6. “Payments” are purely voluntary, and may be made at any time of the loan after funding. This is an especially valuable tool for Eldercare planning. Investments may be liquidated and used to legally pay down the debt and be in compliance with medicaid spend down rules, then repatriated at a later date.
7. The FHA HECM HELOC was actually intended to be used as a retirement aid; Bank HELOC loans are not.
8. After the death of the first Spouse, no refinance is necessary, and they may continue using the equity without any ‘hair cuts”, or suspensions.
9. After the second death, the heirs have 30 days to notify the Lender. Upon the contact call, the lender will automatically grant the Borrower a 6 month window to decide and execute their plans for curing the loan. If no cure is possible (debt exceeds the value)? heirs simply hand over the keys and walk away (take the family stuff. The Lender does not want your chattels). If the heirs need more time? Another 90 days will be granted, and then (upon family request) another 90 days. During this 13+ month period? No mortgage payments are required, (but may be made if the Heirs see a value in doing that),

No legal and attorney fees are added as long as the family is in earnest to cure the debt. (No Bank HELOC) can make that statement in ANY capacity. If the heirs of the Client are struggling now? How can they make payments on servicing the forward mortgage debt? The FHA HECM HELOC is a wonderfully kind way of financing your retirement, and not at the expense of your Heirs.
10. As long as the debt is not entirely paid down (keep a $1,000 debt. The kids can afford that) any deposits paid will reduce the debt and increase the equity available immediately dollar-for-dollar, and add new equity from the federally insured and inexhaustible equity reserve.
11. A HECM HELOC works extremely well with a Revocable Trust.
12. Life insurance purchased to pay off an existing mortgage while both are living may be repurposed, sold, or cancelled as the FHA HECM HELOC accomplishes much the same outcome of Life insurance (which) pays off principal and leaves a debt and payment free home, but locks up equity vs. A REVERSE HECM HELOC which eliminates a required monthly payment and allows ongoing access to the home equity for the Survivor without the need to qualify for refinancing.
13. Life insurance is a customary and usual way to cure a mortgage. Buy some.

Disadvantages to the  FHA HECM HELOC
1. (Alleged) “high fees” associated with this program. Financial Planners are notorious for making this statement. Oddly? (They never seem to have an alternative number of what they think is a reasonable fee). When asked, NONE of them had any idea what value the high fee provided to the Borrower. In all candor? Without the FHA fee? This would be a horrible exposure to becoming homeless.

2. Difficult to refinance if the home takes a substantial drop in value
3. As compared to the Bank HELOC/ loan limits are only a maximum of 55% of the appraised value; not 80%.
4. As compared to the bank HELOC? Reverse HELOC financial tools are (at best) obscure. There is only US mail or electronic funds transfer (EFT). Equity may only be sent to the Borrower, and no 3rd party transactions are permitted.
5. The FHA will not allow an additional lien on title for any other loan or reason, and no (ethical) lender will try.
6. Some may argue the “negative amortization eats all the equity”. It does not; it ignores the fact the Borrowers get to eat all the equity. Borrowers using their home equity to finance and strengthen their retirement is the entire POINT of the program.
7. If the Client uses a HECM HELOC, they should strongly consider using a Revocable trust vs Probate court to transfer a Title. Probate Courts may interfere with the heirs attempts to sell the property. I am a witness.

Thank you for reading; please feel free to visit www.danturnermortgage.com/blog for more in-depth ideas and techniques of how to use home equity to strengthen your Client’s retirement structures.

 

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