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There are significant advantages in making payments with a reverse mortgage that are not well known. The Home Equity Conversion Mortgage (HECM), commonly referred to as a reverse mortgage, doesn’t require monthly principal and interest payments through the life of the loan. In fact, that’s a common selling point of the product.
However, homeowners are so intrigued with the elimination of a principal and interest mortgage payment that they miss a great opportunity to maximize the advantages of the product.
Why would homeowners voluntarily make payments?
Many older homeowners think obtaining a reverse mortgage means giving up their equity (and the home) to the bank. So, why make payments when you don’t own the home? But that’s not the way the HECM product works. The homeowner continues to own the home through the life of the loan, and so reducing the loan balance with periodic prepayments will increase their equity position.
The decision to make prepayments depends on the motives of the homeowner and his or her ability to make payments. A borrower may choose to make a partial prepayment because his or her financial circumstances have improved and he or she wishes to preserve more of the equity in the property. A homeowner may also be looking for a potential tax deduction.
LOC Growth
Some homeowners make payments to increase future monthly payouts or to increase their growing line of credit.
That’s right. The available line of credit (LOC) grows naturally at the current interest rate plus 0.50% and also with each prepayment. This will give the homeowner more accessible funds in retirement, regardless of future home value. Whatever the motivation, advisors are recognizing the advantages of using HECMs for financial planning purposes.
Keep in mind, when homeowners make payments toward an adjustable-rate HECM loan balance, they should see the following results:
- The loan balance DECREASES
- The equity position INCREASES
- The Line of Credit (LOC) INCREASES dollar-for-dollar
- The borrower will receive IRS Form 1098 (potential tax deduction)
Be aware that borrowers cannot pay more than their loan balance to gain a larger LOC. In fact, paying the loan balance down below $100 allows the servicer to close the HECM and its line of credit. This would be unfortunate for those wanting to use it later in retirement.
The ability to make prepayments is a prudent financial planning strategy and should be great news for every older homeowner.