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Possibly the most amazing feature of the adjustable-rate Home Equity Conversion Mortgage (HECM) is the line of credit (LOC) and its growth feature. This is unique in the world of finance, and it is the primary reason reverse mortgages are useful in financial planning.
Nearly all HECMs offered today are adjustable-rate mortgage (ARM) products. This is because homeowners want an open-end line of credit, a monthly payout, or a combination of those two options. Those options are only available with the ARM. “Open-end” means one can borrow from it at any time, pay it down, and borrow from it again with few restrictions. In fact, many will use the LOC to manage cash flow and prepare for emergencies.
There are so many great advantages to having a HECM LOC and I’ll list a few here:
The LOC is LIQUID: If you need funds, they are easily accessible. Simply request them. For this reason, it is an effective emergency fund.
The LOC is SECURE: The LOC is not capped, reduced, frozen or eliminated as a result of market conditions or property value declines.
The LOC is NOT “BORROWED” until drawn: For this reason, the available LOC does not accrue interest and mortgage insurance.
The LOC GROWS: Unused proceeds will grow on the borrower’s behalf creating a greater capacity to borrow funds in the future.
LOC Growth
There are two things that cause HECM LOCs to grow – time and payments. I won’t cover the math behind it here, but the homeowner’s borrowing capacity grows naturally at the same compounding rate of the loan balance. That is why increases in interest rates can be advantageous for some homeowners – the LOC grows even faster over time.
Homeowners can also increase their LOC by making payments to reduce their loan balances. The lesson to be learned is that if a homeowner has discretionary cash available, it may be prudent to pay down the reverse mortgage balance. This will boost their LOC even more.
Keep in mind, declining property values don’t impact the LOC growth. In fact, the LOC may even grow to exceed the home’s value. This can happen if 1) property values decline, 2) if a homeowner holds an LOC for longer periods, or 3) if interest rates rise dramatically causing the LOC to grow faster.
Warning: If you intend to keep the LOC for financial planning, make sure not to pay down your loan balance below $100. This could close your reverse mortgage and, by extension, close your LOC.